A Dozen Things I Learned Being Involved in one of the Most Ambitious Startups Ever Conceived (Teledesic)

 

 

I’ve decided to write this blog post about one of the more interesting business stories that has never really been told accurately. The story started for me when I was hired in 1994 to join a company that would become known as Teledesic as the fourth employee. This startup’s mission was to provide communications to the world regardless of location. Early in the process of designing the system it become evident that the nature of the available spectrum when combined with the greatest market need meant that it should be focused on providing broadband communication and not just telephony services. I had been involved in the mobile industry since the 1980s and knew the power of communications to make people’s lives better. So the mission of the startup was very appealing to me.

Craig McCaw and Bill Gates were the founding shareholders of the company, but were not involved in the day-to-day business of the company. My friend Russ Daggatt was the second employee to join the company and Elaine Ferguson was our co-conspirator. We started Teledesic in a couple of furniture cubes in the offices of what was then McCaw Cellular (it was sold to AT&T two years later). We had nothing really at the start but a modest amount of cash, our chutzpah and the reputations of our founding shareholders. Teledesic’s plan was audacious: build and operate more active satellites than any other previous satellite constellation – originally the plan was for 840 active satellites (reduced to 288 satellites in 1997). The original estimate of the system cost before any service could be provided was $9 billion. The idea for Teledesic was a spinoff of a military system called “brilliant pebbles.” Ed Tuck originated the idea for Teledesic, but it had been shepherded by the first employee, an engineer named Dave Patterson. There were many other very talented people involved in Teledesic that I could name but this is a short blog post not a book (which I may write some day). Some people involved Teledesic may disagree with aspects of this post since experiences like this are a bit like the famous Japanese movie Rashomon by Akira Kurosawa. If you have seen that movie you know it is about different people recalling contradictory versions of the same intense collective experience.

I turned down an offer of a very attractive job Microsoft the day I joined Teledesic in 1994. That day I told Bill Gates that I felt a need to do an ambitious startup sometime in my life and that I was passionate about making Teledesic happen. He said he understood why I turned down the Microsoft job, but he probably thought I was nuts. Not too nuts though, since he was an founding investor in what I was about to do. I have written before on this blog that the ideal venture investment is “half nuts” so it has the requisite convexity to create the potential for a 50-1,000x financial return. I also have written many times on this blog that missionaries act differently and are willing to do more things to make a startup successful than mercenaries. From 1994 until 1999 I threw my life into making Teledesic’s business a reality. You probably have heard the story about the chicken being involved in breakfast because she laid an egg but that the pig was committed to breakfast since he supplied the bacon. Investors are like the chicken, but startup up employees are like the pig. I flew over 500,000 air miles a year for five straight years to help retire Teledesic’s financial, regulatory and technical risk. I worked constantly. Other Teledesic employees where working just as hard accomplishing  impressive things on the technical, business and regulatory aspects of the business. An amazing multi-disciplinary team was assembled in Kirkland, which is a suburb of Seattle. If I name one more of these people I would feel compelled to name them all.

Based on the incredibly positive reputation of our founding shareholders we were able to meet with just about anyone on earth in developing Teledesic. People I met with around the world inevitably would look at me dumbfounded as I told them about a constellation of hundreds of satellite circling the Earth providing broadband service. The New York Times once called the number of satellites involved in the Teledesic system design “mind boggling.” But since Craig McCaw and Bill Gates were involved most of these people not only listened but decided to get involved. The arc of the startup’s existence coincided with the Internet bubble so we had a tailwind that enabled us to plan to make fantastic things happen.  The business climate for new ventures like Teledesic started to get even more positive when the Mosiac browser was released on November of 1993. After Netscape went public in August of 1995 the business and investing climate in the technology world started to get euphoric. Raising the $9 billion needed to build the system seemed more possible every day.

Like any startup that is worthy of venture capital Teledesic had all the elements of “the struggle” for the team trying to make it happen. Sleepless nights. Worries. Things going right and wrong. When I talk to a founder, my experiences at Teledesic color my world view and advice. Ben Horowitz describes the struggle involved in a startup beautifully:

“Your product has issues that will be very hard to fix. The market isn’t quite where it was supposed to be. Your employees are losing confidence and some of them have quit. Some of the ones that quit were quite smart and have the remaining ones wondering if staying makes sense. You are running low on cash and your venture capitalist tells you that it will be difficult to raise money given the impending European catastrophe. You lose a competitive battle. You lose a loyal customer. You lose a great employee. The walls start closing in. Where did you go wrong? Why didn’t your company perform as envisioned? Are you good enough to do this? As your dreams turn into nightmares, you find yourself in The Struggle.”

There were many things to worry about at Teledesic. We faced technology risk, financial risk and market risk. The experience was exhilarating and frightening at the same time. Teledesic did not have the support of everyone in the orbit of the founders in the early days. At one point when the startup had only had seven employees an executive named Wayne Perry who had worked with Craig McCaw for many years in the mobile and cable businesses said: “The problem with Teledesic is Russ and Tren – they just won’t let it fail.” Wayne was not a fan Teledesic in its early days, but many other people were fans. People in general love space-based businesses. Who doesn’t marvel as they look up at the sky on a clear dark night?

Through sheer force of will, the reputation of the founding shareholders  and a lot of work, the small but growing team at Teledesic took the business forward clearing regulatory and other hurdles that others thought would certainly kill us. The peak of achieving the impossible was in 1995 when we achieved a regulatory win thought unwinnable at a World Radio Conference in Geneva. What we did in about six weeks in Geneva was simply unheard of in regulatory circles. Wired magazine wrote at the time:  “It was a giant party, complete with favors,’ said an executive at wireless phone company Qualcomm, who, like seven other attendees of the 1995 conference interviewed by Wired News, talked about the conference on the condition of anonymity. These seven echoed the accounting of events at the WRC ’95. Other delegates remembered it differently – as a lobbying effort never before seen at a World Radio Conference. ‘What was unprecedented, I believe, was the scale and systematic aspect of this lobbying effort,’ noted a French delegate.” We were pirates with an entertainment budget and modern communications tools like the Internet and mobile phones. I loved being a pirate. It is about as much fun as you can have with your clothes still on.

By the fall of 1998 other opportunities were proliferating in the business world and I was asked by Craig McCaw to become more involved in other aspects of his communications and software businesses. By 1999 I was only involved in Teledesic as an advisor. By then the Internet bubble was in near full swing with lots of interesting and challenging things to do in private equity and venture capital.  A talented team was in place at Teledesic to take it forward so I felt relatively good about moving on. I did have one major nagging concern. Giant companies like Boeing and Motorola were getting involved as Teledesic contractors and that meant space and other systems for Teledesic which kept growing both in terms of size and cost. The involvement of the huge contractors also made being involved in Teledesic less fun.  The days of being a pirate in a startup known as Teledesic seemed to be ending, and were being replaced by traditional processes and thinking typical in giant defense and space companies. One brilliant thing that founders like Elon Musk and Jeff Bezos are doing today with their involvement in space-based businesses is not creating  dependencies on these traditional high cost contractors. To do so would create wholesale transfer pricing problems that would kill their efforts to reduce cost, as I will explain below.

At the time I ceased being a Teledesic employee in 1999 people still believed in the dream especially since by then valuations were skyrocketing daily as people suspended disbelief about many aspects of financing a business. Anything seemed possible during those years, even the idea of raising the needed $9 billion for building the proposed Teledesic satellite system. But about two years later the business climate changed for the worse rather abruptly. People who did not live through the internet bubble simply don’t understand how quickly things changed. One day you could raise billions of dollars to build something like a massive fiber based national or global telecommunications network and the next you could literally not raise 3 cents. Just reading about this shift in the ability of a business to raise new funds is not sufficient to convey how swift the change from internet bubble to internet bust really was. If you went through the internet bubble and its collapse you were forever changed. Your muscle memory is just different than other people who did not have the same experience.

In the end the financial, technical and business risks associated with Teledesic could not be retired. A non-geostationary system must serve everywhere to serve anywhere so the constellation was an all or nothing effort. The ground antennas given technology at the time would have been too expensive and complex given the frequency band (Ka) and the satellite system costs were just not low enough since a cubesat approach was not being adopted. Non mechanical inexpensive antennas at that frequency are still a year away from being available even today. When Teledesic was trying to purchase launch services in 2001 entrepreneurs like Elon Musk and Jeff Bezos were not driving down launch costs and cubesat-style satellite systems were not being built yet since Moore’s law was not quite far enough along. The traditional manufacturers like Boeing and Motorola did not want to enable cubesat-style systems, so cost estimates skyrocketed and satellite size ballooned. The traditional manufacturers wanted to re-use the massive satellites they had already developed so the number of satellites in the proposed system needed to be reduced. These traditional manufacturers did not want cheap satellites since their military and government customers would want them too. They liked the idea of PhDs assembling massive satellites in clean rooms out of custom parts since it created a barrier to entry. I wrote about this price elasticity problem of a legacy manufacturer in my blog post on Elon Musk. Sometimes people will say that the Teledesic system shrunk in size since Boeing or Motorola had a better design. That is bullshit. The proposed Teledesic system shrunk because the legacy satellite manufacturers had huge satellites they already manufactured and they did not want to make small satellites since that would require new engineering and a new business model. Most importantly, the legacy satellite manufacturers did not believe they would sell many more satellites if they were cheaper.

Elon Musk and others like Greg Wyler’s OneWeb satellite system have revived the original Teledesic idea of constellations of hundreds and even thousands of satellites. I am optimistic these systems will get built and become operational. What is different now and what might make it happen? First, Moore’s law has had a couple of turns since then and more is possible at substantially less expensive price points. But more importantly a new group of people have been making very small “cubesats” in ways that some more traditional people involved in space would consider “a toy” These cubesats are tiny and simple by traditional standards and manufactured from off the shelf parts in many cases in a relatively normal manufacturing facility at far lower cost. These cubesats are getting better and better and can be up-sized to bigger dimensions (for example 250 kilograms) to make them powerful enough to do communications and not just imaging. The biggest question I have actually is not whether these system can be built and financed but rather: what is the total addressable market (TAM) for these communications systems given the cost of the services and the the necessary antennas? Is there enough demand and the prices that will be charged to make the business case work financially? The radio frequency bands (Ka and Ku) and distances involved most likely mean the communications systems will be used for communications backhaul. Low frequency LTE on the satellite does make not make much sense (channel bandwidth and structure are completely different). Greg Wyler’s OneWeb is planned for Ku/Ka frequencies and therefore is likely to be a system that will be used as backhaul for mobile cell towers and by big customers like the military. I am skeptical that the pictures of small villages using the system to create direct links to the satellites depict a realistic market scenario, but they do help with regulatory approvals. More communications backhaul in hard to reach areas is good for the world, but these systems are not likely to be an affordable scalable broadband communications end-user solution for ordinary users. Having said that, providing emergency broadband communications capability in areas with problems like epidemics and natural disasters is important. Will backhaul be nearly all fiber and terrestrial microwave or will some satellite satisfy some of the demand? What role can drones play in all of this?  Is there enough other demand from other markets like ships, airplanes, NGOs  and the military to make the systems financially successful? I have opinions on that market demand and approaches like drones, but writing about that topic is not right for a short blog post like this. There is already a risk that you may be getting a little bored with parts of this story. In any event, we will find out about the size of market demand for space-based communications systems soon enough.

During its life, the Teledesic team raised over a billion dollars at a valuation that was as  high as a $3 billion. Teledesic was a triple Unicorn in its time. But when it was determined by the Teledesic board of directors that the business could not retire enough of the financial, technical and business risks to proceed, a decision was made to liquidate and hundreds of millions of dollars were distributed back to shareholders. This distribution of cash back to shareholders was and still is relatively unprecedented since most companies in a similar situation just pivot again and again to new businesses ideas until the cash is all gone. The math of corporate finance meant that early Teledesic investors received a significant multiple as a financial return on their investments even though it was a liquidation. One early investor to this day marvels that he received many times his original investment in a company that never provided service. Shareholders who invested at a higher valuation like $3 billion were not so fortunate.

Winding up any startup is never a happy time, but Teledesic was a valiant effort undertaken by a very talented team that paved the way for other similar systems to be built someday. It was also great fun and a wonderful life experience to be involved in the startup, especially in the early days. As Jeff Bezos wrote recently, “failure and invention are inseparable twins.” Negative results provide knowledge to everyone about what will not be a success. That makes it easier to determine what can be successful. Failures enable us to not only make new mistakes but to create genuine and lasting innovation. If you are not occasionally failing in what you do, you are unlikely to achieve great things.

A Dozen Things I Learned at Teledesic:

  1. It is more fun to be a pirate than join the navy. Pirates know how to break the eggs needed to make the necessary omelet. We broke a lot of eggs.
  2. Most people are not cut out for the startup life. It is not for everyone.
  3. Certain periods in your life are right for being involved in an audacious startup, and other periods are not.
  4. Flying 500,000 air miles a year for five years takes a big physical toll on your body. I still pay a physical price for that time in my life.
  5. Almost everything in life that is technically interesting and important involves trade-offs.  This is especially true in space.
  6. The more great people you hire, the easier it is to hire great people. Positive feedback can be powerful.
  7. The better the quality of your existing shareholders, the easier it is to attract new high quality shareholders.
  8. Having smart, talented and accomplished lead investors is invaluable in raising funds.
  9. Space is very big. The distance to a non-geostationary orbit around the Earth is not so big, but launching any mass into that orbit is still relatively expensive.
  10. There are no electrical outlets or power cords in space. This creates hard problems for systems that need power. 
  11. Since power density of an electromagnetic wave is proportional to the inverse of the square of the distance from a point source, space-based communications isn’t easy.
  12. Billionaires love space and rockets.  A rocket launch is like a big very controlled explosion.  Explosions that are very controlled and hurt no one can be great fun. Billionaires like to have fun.

 

Notes:

Wired on Teledesic:   http://archive.wired.com/science/discoveries/news/1997/10/7655

New York Times on Teledesic: http://www.nytimes.com/2000/06/04/business/can-craig-mccaw-keep-his-vision-of-teledesic-from-crashing.html?pagewanted=all

The Teledesic System: http://3csysco.com/Pubs/Teledesic%20Satellite%20System%20Overview.pdf

The Struggle by Ben Horowitz  http://www.bhorowitz.com/the_struggle

 A Dozen Things I’ve Learned from Mark Cuban About Business and Investing

 

  1. “I’m always selling. Always.” “Learn to sell. In business you’re always selling – to your prospects, investors, and employees. To be the best salesperson, put yourself in the shoes of the person to whom you’re selling.  Don’t sell your product. Solve their problems.” “No sales, no company.” “Make your product easier to buy than your competition, or you will find your customers buying from them, not you.” “Treat your customers like they own you. Because they do.” “Your customers can tell you the things that are broken and how they want to be made happy. Listen to them. Make them happy. But don’t rely on them to create the future road map for your product or service. That’s your job.” Being an effective salesperson is significantly underrated as an important life skill, especially by engineers who too often hope that a great product will sell itself. In thinking about the value of the ability to sell it is wise to remember that people sell much more than just products. For example, you were selling when you received your first romantic kiss. People must sell themselves to a potential spouse or “significant other” person. A business owner not only sells product but the company to employees and distributors. I have a good friend who likes to say that “everyone is talking their book all the time.” This is true and it is clear that some people are much better at talking their book than other people. It has been my experience that the best salespeople don’t even appear to be selling. I had a late friend who people said was such a good salesman that he was capable firing someone and that person would not know they were fired until they were at home that night telling their spouse about their day. “Hey, wait a minute…” On the last point Cuban makes above on future products, he seems to agree with Steve Jobs, who once said in an interview:

Business Week: Did you do consumer research on the iMac when you were developing it?
Steve Jobs: No. We have a lot of customers, and we have a lot of research into our installed base. We also watch industry trends pretty carefully. But in the end, for something this complicated, it’s really hard to design products by focus groups. A lot of times, people don’t know what they want until you show it to them. That’s why a lot of people at Apple get paid a lot of money, because they’re supposed to be on top of these things.

 

  1. “Sweat equity is the most valuable equity there is.” “Everyone has ideas, but most people don’t do the work required to get the job done.” “It’s not about money or connections — it’s the willingness to outwork and out learn everyone.” “You accomplish much more with direct relationships than by using an intermediary.” Sweat equity is not only the cheapest form of equity to acquire, it is the most rewarding as well. But more than just acquiring cheaper equity is going on when you do something yourself since it means you are in the best position to know whether you are getting value and the real cost of the work. A person always has some path loss when they use an intermediary and path loss in not a good idea when a person can benefit so much from having accurate information. Young children are often taught about this idea when they are introduced to “the telephone game” in which a message is passed on in a whisper from person to person. The final version of the message is usually radically changed from the original after the person to person whispering is done, which teaches the lesson. If you always use a vendor to accomplish a task you may never fully know what is actually happening in your business. As an aside, when I say “path loss” in this context I am not referring to the reduction in power density of an electronic wave as it propagates through space. I refer to messages getting garbled when they travel from person to person.

Your Memory is like the Telephone Game: “A memory is not simply an image produced by time traveling back to the original event — it can be an image that is somewhat distorted because of the prior times you remembered it,” said Donna Bridge, a postdoctoral fellow at Northwestern University Feinberg School of Medicine and lead author of the paper on the study recently published in the Journal of Neuroscience. “Your memory of an event can grow less precise even to the point of being totally false with each retrieval.”

 

  1. “Whatever business you have, there is always someone trying to put you out of business.” “Business is a 24/7 job where someone is always out there to kick your ass.” Cuban’s point captures the essence of what Joseph Schumpeter called “creative destruction.” Other businesses are always out there trying to take your customers with a better product offering or a better a sales approach. This process that Schumpeter described is the engine of capitalism and results in the continual transformation of producer surplus to consumer surplus. This transformation process is happening faster than ever, which weirdly has caused some economists to believe innovation has slowed since producers surplus growth has slowed. Anyone who is actually engaged in business knows that the idea that innovation has slowed is completely detached from reality. Current business conditions are more competitive than ever. If you do not have a moat to prevent someone from capturing your customers, your profit will quickly disappear. Competition takes many forms and comes from many places. Harvard Business School Professor Michael Porter teaches his students competition can come from many sources such as customers, suppliers, potential entrants, and substitute products. Be careful out there…

 

  1. “Most people think it’s all about the idea. It’s not. Everyone has ideas. The hard part is doing the homework to know if the idea could work in an industry, then doing the preparation to be able to execute on the idea.”  I doubt there many people above the age of 12 who have not said at least once when they see a successful business: “Hey, I thought of that idea first.” There is a vast gap between thinking about a business and actually doing what is needed to create the business and make it a success. If you are not willing to do the work and take risk nothing will ever be more than an idea. The ability to execute on an idea much rarer than people imagine. Cuban is saying that people who do the preparatory work first and avoid “fire, ready, aim” are much more likely to be successful in life. This point made by Cuban reminds me of Benjamin Franklin who famously once said: “By failing to prepare, you are preparing to fail.”

 

5. “Focus on finding big problems.” A business that serves a big attractive market is much more likely to be a success.  Many businesses fighting over a niche market is not a pretty sight. The venture capitalist Eugene Kleiner said once that a few businesses fighting over a niche market is similar to a few bald men fighting over a comb. Cuban’s point reminds of of one of my favorite Gary Larson Far Side cartoons which involves two spiders sitting next to a playground slide with a spider web stretched across the bottom. One spider is saying to the other spider in the caption: “If we pull this off we’ll eat like kings!” Thinking big pays big dividends when operating a business.

 

  1. “Don’t start a company unless it’s an obsession and something you love. If you have an exit strategy, it’s not an obsession.” If you are missionary and not a mercenary the probability that you will create a successful business goes way up. You will work harder and survive the tough times far better if you love what you are doing and are obsessed with the business. Missionaries are not thinking much about exit strategies since their focus is on getting the job done and achieving their objectives. Which reminds me of  joke.  Two missionaries were captured by a tribe of hostile cannibals who put them in a large pot of water after building a huge fire under it. A few minutes later, one of the missionaries started to laugh uncontrollably. The other missionary could not believe what he was hearing and said: “What’s wrong with you? We’re being boiled alive! They’re going to eat us! What could possibly be funny at a time like this?” The other missionary responded, “I just peed in the soup.” This joke has nothing to do with starting a business, but it is funny and involves missionaries.

 

  1. “[Diversification] is for idiots.” “You can’t diversify enough to know what you’re doing.” Warren Buffett is agreeing with Cuban when he says: “Risk come from not knowing what you are doing.” Buffett believes: “concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it. In stating this opinion, we define risk, using dictionary terms, as “the possibility of loss or injury. …You only have to do a very few things right in your life so long as you don’t do too many things wrong.” Of course, if you don’t want to do the work to “know what you are doing,” then diversity. Dumb or lazy money becomes smart money when people realize that they are dumb or lazy.  A person’s got to know his or her limitations, as Dirty Harry famously said. Some people are hard working and thoughtful in the rest of their life but lazy and not thoughtful when it comes to investing. They spend more time picking out a shirt in a store than on selecting their investments and their investing results reflect that emphasis.

 

  1. “In every job, I would justify in my mind, whether I loved it or hated it, that I was getting paid to learn and every experience would be of value when I figured out what I wanted to do when I grew up. It is time to get paid to learn.” Until you get out of college you are usually paying to learn. Or at least someone like your parents is paying for you to learn. But after you graduate from college your goal should be to be paid by other people to learn. The more you learn in a given job, the more valuable that experience will be for you and the more other people will want to pay you to learn more.  This is an example of a positive feedback loop and my own life is an example. I have been paid to learn my entire career since I left graduate school. The more I learned in life, the more people have wanted to pay me to learn more so I can help them solve problems and find new opportunities.

 

  1. “When you’ve got 10,000 people trying to do the same thing, why would you want to be number 10,001?” “What I do know, at least what I think I have learned from my experiences in business, is that when there is a rush for everyone to do the same thing, it becomes more difficult to do. Not easier. Harder.” Competition drives down prices to levels where financial return is equal to the opportunity cost of capital. That is the essential truth of capitalism and its engine. The goal in any business is to create some non-replicable advantage that is a moat against competition. Barriers to entry should be the goal of any business.  The deeper and stronger the moat the happier the business owner will be with their financial results. Finding a source of differentiation is a beautiful thing. Harvard Professor Michael Porter puts it this way: “It’s incredibly arrogant for a company to believe that it can deliver the same sort of product that its rivals do and actually do better for very long.”  If you deliver the same product or service as your competitor you by definition don’t have a moat.  Competition will in that case be based on price and price-based competition inevitably degrades to a point where profit disappears.   Porter teaches:  “If customers have all the power, and if rivalry is based on price… you won’t be very profitable.” He adds: “Producing the highest-quality products at the lowest cost or consolidating their industry is trying to improve on best practices. That’s not a strategy.” Cuban is making an additional point here about how a crowded market for X, makes achieving X harder and not easier.  Resources become more scarce when there is a so-called crowded trade going on.

 

  1. “It doesn’t matter how many times you have failed, you only have to be right once.” Michael Mauboussin elaborates on the point Cuban is making: “In any probabilistic exercise: the frequency of correctness does not matter; it is the magnitude of correctness that matters.” This is the so-called Babe Ruth effect. Mauboussin writes: What is striking is that the leading thinkers across varied fields — including horse betting, casino gambling, and investing — all emphasize the same point.” Chris Dixon has a great post on this that I link to in the notes. Dixon points out: “The Babe Ruth effect is hard to internalize because people are generally predisposed to avoid losses.” If you can overcome this loss aversion and learn to benefit from convexity (big potential upside, small potential downside), you can beat the market averages. Doing this successfully is relatively simple concept to understand, but is not easy to do since most mistakes are emotional or psychological. I have said before I think ~10% of people are capable of beat the market but only ~3% are willing to do the work to actually do so. The problems are in no small part created by the fact that more than half of investors think they are in that 3%.

 

  1. “Never put your money in something where you don’t have an information advantage.”  “Most people won’t put in the time to get a knowledge advantage.”  Charlie Munger agrees with Cuban and advises investors to “Look for more value in terms of discounted future cash-flow than you are paying for. Move only when you have an advantage.” In trying to buy something for less than it is worth, you should be working to create an information advantage over the seller. How do you do that?  Howard Marks points the way: “Mistakes are all that superior investing is about.  In short, in order for one side of a transaction to turn out to be a major success, the other side has to have been a big mistake. There’s an old saying in poker that there’s a “fish” (a sucker, or an unskilled player who’s likely to lose) in every game, and if you’ve played for an hour without having figured out who the fish is, then it’s you.  Likewise, in every investment transaction you’re part of, it’s likely that someone’s making a mistake.  The key to success is to not have it be you.”  If you do not have an information advantage or are not willing to do the work to get an information advantage, put your money in a low cost diversified portfolio of index funds.

 

  1. “I placed too much importance on comparing how much I had to others early on. Then I started realizing time was a far more valuable asset.” “The cheaper you can live, the greater your options.”  Jealously is a useless emotion. Nothing good comes from jealousy. Ever. It is a far better idea to focus any energy that would be wasted on jealousy on creating more time to do what you love. The best thing that money can give you and people you love is better choices. People who do not have any money have terrible choices. Over the years I have seen a lot of people with expensive luxury possessions  who do not have the cash required to always have the ability to make have good choices in their life. Liquidity matters. Howard Marks recently said: “When you go into risk assets and they go through a tough period, there will be heartburn and price declines. If you are going to need the money in the short term, you shouldn’t put it into potentially illiquid assets.” Having enough cash in the bank so you always have good choices is the ultimate luxury. No car, boat or house could ever be better than that feeling. CNBC’s Joe Kernan said to Marc Cuban in 2000: “Don’t you feel dumb that you cashed out your Yahoo stock at $200 & now it’s trading at over $230?”” Cuban answered: “Well, it’s hard to feel dumb when you’re flying around in your GV.” More importantly Cuban added: “I asked myself – what’s the worst that could happen? I walk away with $2B in the bank? How much money do I really need?”

 

Notes:

USC Interview  https://www.youtube.com/watch?v=fs9Gr8Gj6Cg

Inc Interview  http://www.inc.com/lindsay-blakely/mark-cuban-sterling-nba-entrepreneurship.html

Young Money Interview: http://finance.youngmoney.com/entrepreneur/entrepreneur-advice/041703_01/

Blog Maverick  http://www.businessinsider.com/mark-cubans-guide-to-getting-rich-2015-9

Twelve Rules   http://www.businessinsider.com/mark-cuban-rules-startups-tips-strategy-entrepreneur-2015-5

Michael Mauboussin on Babe Ruth:  http://turtletrader.com/pdfs/babe-ruth.pdf

Chris Dixon on Babe Ruth:   http://cdixon.org/2015/06/07/the-babe-ruth-effect-in-venture-capital/

Memory: http://www.northwestern.edu/newscenter/stories/2012/09/your-memory-is-like-the-telephone-game.html

A Dozen Things I’ve Learned from Jenny Lee about Investing and Business

“Jenny Lee joined GGV Capital in 2005 as a managing partner and was instrumental in setting up the GGV presence in China. Her previous operation and finance work experience with Singapore Technologies Aerospace, Morgan Stanley and JAFCO Asia enhanced her role as a preferred board mentor and investor to many entrepreneurs in China. She graduated from Cornell University with a Masters and B.Sc. in Electrical Engineering and an M.B.A. from Kellogg School of Management, Northwestern University.” 

1. “Start-ups aren’t an object. They’re successful because of the people behind them.” Great people, attractive markets, significant innovation are the three key elements in any successful business. What a venture capitalist wants to find in a founder is a certain sort of person. These founders are not identical, but do share certain attributes. One of the desired attributes in a business founder is a missionary attitude toward the business. Missionaries rather than mercenaries are the founders who create the startups that make the biggest impact. Other desired qualities in a founder include persistence, curiosity, energy, the ability to communicate and sell, focus, determination, intelligence and the ability to adapt to change. These attributes should be sought not just in founders but in the teams they assemble to build and run the business. Having a diverse team in every sense is important. Different people have different skills and sometimes someone’s strength is also their weakness.

 

2. “[Founders] must have the hunger to learn about new things and have the tenacity to persist in one’s judgment despite naysayers – and there will be a lot of them – and, finally, that firm belief that a single person or a single company can create products or business models that can change the world.” “You need to believe that you can clear everything in your path.”  Some people may think it is an odd combination, but founders who are confident and yet humble are mostly likely to succeed. The more you know and the more experience you get in life, the more humble you should be. Part of the reason Charlie Munger is so wise is that he believes: “Knowing what you don’t know is more useful than being brilliant. … real knowledge is knowing the extent of one’s ignorance.” Successful founders tend to have strong views, loosely held. If you do not have strong views, you have not done the research and probably don’t know both sides an issue. If those strong views are not loosely held, it is unlikely you will be able to adapt as new information and ideas arrive.

 

3.“We are looking for the 2% who are going to change the world.” Tape measure home runs drive financial returns in the venture capital industry. To get a tape measure home run you must have founders who are aiming to significantly change the world since otherwise the revenue and profit growth will not be sufficient. The best venture capitalists are constantly searching for outliers. This must be the case given how high the bar has been set by the venture capital business model. To explain how high the bar is set, this is my riff on a quote by Warren Buffett using new numbers and slightly altered language:

“Think about a company with a market cap of $1 billion. To justify paying this price, you would have to generate profit $100 million every year until perpetuity, assuming a 10% discount rate. And if the business doesn’t begin this payout for a year, the figure rises to $110 million annually, etc. Think about how many businesses today generate profit of $100 million a year.”

Consider how big a financial win must be to move the needle in venture capital. Fred Wilson described the math in this post: 

“First, the money needs to generate 2.5x net of fees and carry to the investors to deliver a decent return. Fees and carry bump that number to 3x gross returns. So $25bn needs to turn into $75bn per year in proceeds to the venture funds. Then you need to figure out how much of the companies the VCs normally own. The number bandied about by most VCs is 20%. That means that each VC investor owns, on average 20% of each portfolio company. We’ll use that number but to be honest I think it’s lower, like 15% which makes the math even tougher. Using the 20% number, that $75bn per year must come from exits producing $375bn in total value. But it is also true that many of these exits have multiple VC investors in them, sometimes three or four. So you really need to look at the percent ownership by VC funds in the average deal at the time of exit. That number is likely to be over 50% and maybe as high as 60%. If we use 50%, then to get $75bn per year in distributions, we need to get $150bn per year in exits.” 

 

4. “I’m a very gut feel type of investor.” There are no formulas which will always generate success in venture capital.  If there were simple success formulas that could be applied mechanically nearly everyone would be rich.  There are some general principles that can be applied by successful practitioners which can increase the probability of success. One such principle is: venture capital is the search for investment with significant convexity (big financial upside with a correspondingly small downside). When a venture investment is made what the venture capitalist can lose is limited to what they invest. But the financial return can potentially be hundreds or even thousands of times the initial investment. A tape measure home run will not happen often with a venture investment but when it does the venture capitalist may sing the hallelujah chorus even if they are not religious. Finding undiscovered convexity that is being offered at a substantial bargain means the venture capitalist must be continually looking for it in new places. Once an investment idea is appearing regularly in the newspapers and tech blogs it is often too late to find the greatest opportunities. Finding a new approach requires that the approach be new in some important way. There must be at least one key element of the business that is fundamentally different from what has been done before. That something which is different is always different that what was different the last time.

 

5. “It’s a tough market and more of a challenge to find the gems. But it’s a great time to start; the quality of entrepreneurs has increased. I love the winter.” Often the best time to start a business is during a downturn in an economy. The competition for the best employees is lower during a financial correction as is competition in markets generally. During an economic downturn there is also less noise that can distract a business which enables more focus on business fundamentals. In a tough market there is often less thinking about distracting things like pivoting and more focus on getting things done.

 

6. “If you’re a late-stage company, a growth-stage company, and you’re looking to be a public company, the market fluctuation does affect you. If you are further down the chain on the early-stage side, then I would say that the capital markets play less of an impact, but it does affect how those companies now think about the quality of that capital, the stability of the capital, and the investor behind the capital.” Being an early stage startup during a downturn can be a relatively good place to be. In contrast, needing loads of capital during a lousy funding environment is not a great place to be. It is inevitably shocking for people going thorough their first business cycle when the cash spigot goes dry (i.e., it becomes hard or just plain impossible to raise new cash). Having a plan in the event the business can raise no new cash is wise. People like Mitch Kapor and Josh Kopelman now are talking about a Watney rule: “We need to act we’re like Mark Watney in the Martian. We can’t assume we will get a shipment of new potatoes to save us.”

  

7. “[Founders should understand the] fit between the company, their sector, the VC firm and the partner in charge.” Every founder and startup has different skills, resources, talents and needs. Every venture capitalist is also unique, as are venture firms.  “Founder-VC fit” is enough of a success factor in building a business that extensive due diligence by founders to find the right investors is wise. Founders should talk to other founders about their experiences with any given venture capitalist before making a choice. Selecting a venture capitalist is like deciding to marry someone. Unfortunately, sometimes there is only one person that will have you. But that is not your ideal situation.

  

8. “For work, if the product is good, there is a paying tendency.” Enterprise customers are more likely to be willing to pay cash for services than consumers who have been conditioned to expect services “for free.” Ben Thompson describes the problem with enterprise sales in a recent issue of his newsletter: “Productivity apps usually have high learning curves.” Most people today are attacking this problem with freemium. During the free period in the freemium model the user gets religion in a very low cost way through self-education and then they are sold the equivalent of guidebooks for that religion and become paying consumers.  Freemium is, at its core, about lowering CAC (customer acquisition cost)! This is the “land and expand” business model use by businesses like Slack and Atlassian which does not require the same level of sales and marketing spending as a Beatles sale and marketing approach (“I want to hold your hand”).  If your competitor is using a land and expand approach they can often undercut your price if you do not adopt it too. The new wrinkle on enterprise investing is that many businesses that once upon a time would have sold tools to enterprise markets have become what is known as “full stack.” Chris Dixon writes: “Suppose you develop a new technology that is valuable to some industry. The old approach was to sell or license your technology to the existing companies in that industry. The new approach is to build an end-to-end product or service that bypasses existing companies.” Oracle sells tools, but Tesla and Uber sell a full stack offering in that they provide everything, including the service to the end user.  This full stack phenomenon and the rise of freemium have many important ramifications that I plan to write more about at some point.

 

9. “The monetization technique in China cannot just be advertising-supported. The China population is actually a paying population. They pay for games, things that they don’t even need. They pay for virtual items so they can look like a duke. They drive a virtual BMW to a concert that’s all online. They can pay. This is the young generation. For them, do I line up, get stuck in traffic, buy a 300 renminbi ticket, be stuck in auditorium? Or can I do that for 100 bucks and look like a king online? So the time has changed, and therefore, if you have users, any company should try to monetize through various ways. That’s how we push our CEOs when they say, ‘Well, this is how the West does it.’ We say, ‘Let’s see if the East can do it better.’” “[In China] most people do not consume ads online, especially on mobile. “The lack of a fully built-out offline retail and services in second- and third-tier cities in China means that many services and products are not available offline. Variety and convenience factors are lacking. Hence mobile commerce is a very natural transaction-based value for users.  Thanks to Alipay and Tencent’s further efforts to tie users’ phones to payment providers, the ease of payment has greatly enhanced e-commerce, and anytime anywhere transactions via the mobile devices.” China is not only a huge market but a key part of the global supply chain. As a market and supply base doe most companies it cannot be ignored. So for a business the right question is how you deal with China rather than whether you deal with China. I spent four years of my life working in Seoul Korea and even wrote a book about doing business in that country. What I took away from that experience of living in Korea and later Australia was how little I know about the country despite living there and that even if I spent a lifetime working there I would still have much more to learn. When dealing with a county and culture where you are not a native, it is wise to know as much as you can about what you do not know. To help deal with cross cultural and other differences it is best to have a relationship mentality rather than a deal mentality.  That is the principal thesis in my book The Global Negotiator, which is free to read on my blog:  https://25iq.files.wordpress.com/2016/05/the_global_negotiator.pdf

 

10. “One of the most common questions we hear today is, ‘How can I take my model to the other side?’ U.S. companies always come to us and say, ‘I am doing this in the U.S. Should I be doing it in China first?’ If you’re an entrepreneur, you’re no longer just thinking ‘my hometown.’ Some of them come from the point of: ‘If I don’t do this on a global basis first, someone is going to copy me.’ I’m sitting in China; somebody is going to copy me in the U.S. I’m sitting in the U.S.; somebody is going to copy me in China.”  Once upon a time people thought of innovation as happening in the west and then moving to China. Now the flow is moving in both directions. This is a very good thing since the world benefits from more innovation.

 

11. “If you can do without China, and you have this fear of setting up there, then don’t go. But if you are in the makers community, 90 per cent of your supply chain is in China. So in not going, you will fail.” “Maybe you can find that 10 per cent in Vietnam, but the price is not going to be the same (and you will encounter the same problems anyway.) If your business requires you to be in China, then my advice as an entrepreneur is figure how to get smart about it. It is as simple as that. There’s no perfect answer.” China is not only a huge market but a key part of the global supply chain. Not only is China a great opportunity for any business but in some industries it simply can’t be ignored. So for a business like this they face a question how they deal with China rather than whether they deal with China.

 

12. “My friends told me I was crazy to leave the iron rice bowl that ST Engineering provided. But I had to take the risk. To get what you want, you must get it yourself.” After graduating from Cornell, Lee started her career in Singapore as an aerospace engineer. She could have stayed in that job and been very secure financially. But instead she did what she needed to do to achieve her goals. Startups are not a great place for people who value security highly. The reality is that most startups fail. The struggle to build a business from scratch is inevitably hard. Elon Musk has said: “A friend of mine said running a start-up is like chewing glass and staring into the abyss. After a while, you stop staring, but the glass chewing never ends.” If you are not a missionary about the mission of a startup the odds that you will endure the many rejections and hardships goes way down. Venture capitalists know from experience that people who are working on the idea or dream of someone else are not as likely to stay the course. Many startups have been inches from failure before the eventually found success. Getting through all the glass chewing is a job best suited for missionaries.

 

Notes: 

Bloomberg:  http://www.bloomberg.com/news/articles/2014-06-13/jenny-lee-of-ggv-capital-has-an-eye-for-chinas-rising-tech-giants

Forbes: http://www.forbes.com/sites/ryanmac/2015/03/25/jenny-lee-midas-list-top-ranked-woman-interview-china/#4d0983ef227e

Inc. http://www.inc.com/lisa-calhoun/34-surprising-facts-about-top-tech-investor-jenny-lee.html

Interview: http://www.techrepublic.com/article/jenny-lee-venture-capital-investor-golfer-fighter-jet-engineer/

http://www.cnbc.com/2015/08/25/top-china-investor-jenny-lee-bets-on-robots-drones.html

Podcast: http://typewriterintl.com/2015/08/25/interviewing-jenny-lee-from-ggv-capital/

Strictly VC http://www.strictlyvc.com/2015/08/12/jenny-lee-of-ggv-capital-on-what-to-know-now-about-china/

Stanford panel: https://www.youtube.com/watch?v=apqd5rWSbfI

Straits Times: http://www.straitstimes.com/business/invest/jenny-lee-a-guiding-star-in-the-world-of-tech-start-ups  http://www.straitstimes.com/business/invest/after-riding-internet-wave-singapores-top-china-investor-jenny-lee-bets-on-hardware

CCTV http://www.cctv-america.com/2015/12/18/venture-capitalist-jenny-lee-eyes-chinas-investment-future

Fred Wilson:   http://avc.com/2009/04/the-venture-capital-math-problem/

A Dozen Things I’ve Learned from Eugene Kleiner about Investing and Business

Eugene Kleiner was an Austrian-born American engineer and venture capitalist. He worked for William Shockley at Shockley Semiconductor Laboratory starting in 1956. The next year he and seven colleagues (the so-called the “traitorous eight“) famously left Shockley to found Fairchild Semiconductor. They left because did not like Shockley’s management practices or his plans to use germanium to make semiconductors. “Using just $3,500 of their own money to get started, these eight entrepreneurs eventually developed a way to manufacture multiple transistors on a single silicon wafer.” Kleiner was one of the original founders of Kleiner Perkins, which was an early investor in more than 300 information technology and biotech firms, including Amazon, AOL, Brio, Electronic Arts, Flextronics, Genentech, Google, Intuit, Lotus, LSI Logic, Macromedia, Netscape, Quantum, Segway, Sun and Tandem. Kleiner’s obituary in the Economist includes this sentence: “To the end of his life, he called himself an engineer.” Despite his technical background Kleiner made major contributions to the world as a financier. That obituary notes it was Kleiner’s letter “to his father’s stockbroker in New York that was passed to Arthur Rock that set off a chain of events that resulted in Rock moving to California and persuading  Sherman Fairchild, the inventor of the aerial camera, to make Mr. Kleiner’s little group a subsidiary of his company.”

 

  1. “Invest in people, not just products.” The KPCB web site elaborates on Kleiner’s first point: “Eugene always respected founding entrepreneurs. He wanted to build companies with them not just with their ideas.” The three legs of the stool that drive venture capital returns are: (1) great people, (2) attractive markets and (3) significant innovation.  If you neglect even one of the three you have a big problem. But there are disagreements among venture capitalists about emphasis and phasing. For example, people like Don Valentine argue that you can always replace the people, so it is better to place more emphasis on attractive market. Venture capitalists like Kleiner believe that replacing people is not only hard and unpleasant, but significantly lowers the convexity of the investment. Great people and teams are able to adapt in ways that solve problems. Without great people already in place, preferably missionaries, the probability of survival is significantly reduced in Kleiner’s view. Elad Gil had an interesting post this week on the importance of great founders which included these two paragraphs:


“There are a handful of venture firms that are always thesis-driven, for example Union Square investing in network driven businesses. However, most venture firms are admittedly reactive – they do not have a specific theme they are driving themselves, but rather respond to where the best entrepreneurs are creating the most high growth, high margin, companies fastest.

When lots of VC firms shift into a thesis driven mode, it is usually a sign that organic entrepreneurial activity is no longer sufficient to drive that firms investments. As a result, lots of capital gets invested in areas that do not merit the investment, there is a flurry of activity that looks important (Cleantech), but ultimately this activity does not yield great returns. Typically these areas are ones where the investors lack real expertise.”

 

  1. “It’s easier to get a piece of an existing market than to create a new one.”  “Two companies fighting over a niche market are like two bald men fighting over a comb.” Kleiner is agreeing with Valentine that attractive markets make the venture capital business model work since there is a need for tape measure financial home runs. The difference is that Kleiner, like Pitch Johnson and many other venture capitalists, consider people to be relatively more important. Kleiner is also saying that it is hard to create a new attractive market where none existed before. He is not saying that creating a new market is not valuable (that payoff can be enormous actually), but instead that it is hard to do. In contrast, fighting with other businesses over a niche market is not likely to be a pleasant or profitable activity.

 

  1. “Risk up front, out early.” A famous venture capitalist said to me about this comment that Kleiner: “Always had a strong bias of eliminating the biggest risks quickly, which was much more relevant in the days of backing companies with high technical risk and low market risk.” Another famous VC who knew Kleiner well wrote to me that what he meant by this sentence was: “Reduce the biggest risks first for the fewest dollars. This may mean out of order execution to minimize loss in case of failure.” Steve Blank points out that there are different types of risk that must be retired for a business to be a success: “Markets with Invention Risk are those where it’s questionable whether the technology can ever be made to work – but if it does customers will beat a path to the company’s door. Markets with Customer/Market Risk are those where the unknown is whether customers will adopt the product.”

 

  1. “The problem with most companies is they don’t know what business they’re in.” Venture capitalists who talk about this problem usually see the flip side which is that it can create opportunity for a challenger. This idea being important in venture capital can be traced at least all the way back to Georges Doriot, who said that US Steel did not know what business it was in.  Other venture capitalists believe businesses like Kodak and DEC late in their life had the same problem as US Steel. In the case of Kodak the company invented the technology that would eventually prove to be its undoing. This point made by Kleiner is applicable to service businesses too. For example, Mark Cuban said once: “You always have to know what business you are in. Everybody thought we were in the basketball business. It’s an NBA-team; we are not in the basketball business. We are in the business of creating experiences and memories.”

 

  1. “Make sure the dog wants to eat the dog food. No matter how ground-breaking a new technology, how large a potential market, make certain customers actually want it.” “There are two types of early adopters. Those who buy and those who want the product given to them.” This quote is a nod by Kleiner to the importance of determining whether there is “product market fit” before scaling a business. Premature scaling is a common cause of startup death. The other point Kleiner is making is that someone must pay for something for a business model to work.  Freemium only make sense as a business model if there is a complementary good that customers are willing to pay for. Rihanna may have a hard time selling music these days since digital music is non rival, but if she uses the fame generated by her music to sell tickets to concerts and t-shirts with her name on them she can still do very well. Her Diamonds World Tour in 2013 grossed US$137,982,530 from 87 shows.

 

  1. “The more difficult the decision, the less it matters what you choose.” Sometimes you are better off making a decision and living with it than agonizing over the decision for a long period and as a result experiencing a significant delay. Kleiner is saying the harder the decision is to make, the more this is true. One famous decisions concerned what material to use in making semiconductors.  William Shockley wanted to use germanium.  Kleiner ans his colleagues wanted to use silicon instead.  People sometimes joke that without Kleiner the term used today would be “Germanium Valley” not Silicon  Valley.

 

  1. “Build one business at a time. Most business plans are overly ambitious. Concentrate on being successful in one endeavor first.”  “What tips me off that a business will be successful is that they have a narrow focus of what they want to do, and they plan a sufficient amount of effort and money to do it. Focus is essential.” The number of people who can run multiple businesses at one time is truly tiny. What Steve Jobs did at Pixar and Apple is not normal.  In addition, the propensity of a founder to pivot is negatively correlated with success. Focus matters. When Bill Gates and Warren Buffett met for the first time at dinner that night “Bill Gates Sr posed the question to the table: What factor did people feel was the most important in getting to where they’d gotten in life? And [Warren Buffett] said, ‘Focus.’ And Bill said the same thing.”

 

  1. “You have to create deals to be really successful.” Success in venture capital is in no small part about hustle. The best venture investors beat the bush for prospects and ideas and have the best referral networks. They are curious and open to new ideas. Reading and talking to people they believe are smart and knowledgeable is a constant activity. Finding the university researchers does not happen by accident. Networks of friends and people you have helped can feed back valuable information in very positive ways.

 

  1. “The time to take the tarts is when they’re being passed.  When the money is available, take it.” “When the hors d’oeuvres are passing, take two.” Venture capital is a cyclical business. Sometimes it is easy to raise money, sometimes it I merely hard and sometimes it is impossible. It is better to have more money than you need and not need it, than need it and not have it. The absence of cash is fatal. So it is wise to have a margin of safety when it comes to cash. Yes, dilution is an issue but if a venture backed business is a hit, there will be more than enough financial return for everyone.

 

  1. “Even turkeys can fly in a high wind. In times of strong economies, even bad companies can look good.” This is a variation of Warren Buffett’s point that: “you only find out who is swimming naked when the tide goes out.” The problem, of course, is that you do not always know when a tailwind is about to rapidly slow or even cease. In fact, sometimes you don’t know if what you are experiencing is a tailwind at all. The best founders are prepared for any outcome.

 

  1.  “It’s difficult to see the picture when you’re inside the frame.” Having perspective on something when you are an insider is hard. Self interest and other biases are powerful enough that dysfunction can result from insider status. The venture capitalist having a network of people who the founders can count on for perspective and feedback is important. Charlie Munger has a great story about this set of issues:

“You also have to allow for the self-serving bias of everybody else, because most people are not going to remove it all that successfully, the human condition being what it is. If you don’t allow for self-serving bias in your conduct, again you’re a fool. I watched the brilliant Harvard Law School trained general counsel of Salomon lose his career, and what he did was when the CEO became aware that some underling had done something wrong, the general counsel said, “Gee, we don’t have any legal duty to report this but I think it’s what we should do it’s our moral duty.” Of course, the general counsel was totally correct but of course it didn’t work; it was a very unpleasant thing for the CEO to do and he put it off and put it off and of course everything eroded into a major scandal and down went the CEO and the general counsel with him. The correct answer in situations like that was given by Ben Franklin, he said, “If you want to persuade, appeal to interest not to reason.” The self-serving bias is so extreme. If the general counsel had said, “Look this is going to erupt, it’s something that will destroy you, take away your money, take away your status…it’s a perfect disaster,” it would have worked!”

 

  1. “Venture capitalists will stop at nothing to copy success.” The venture capital industry has no shortage of camp followers and poseurs like other industries. It is a fact of life that in capitalism that any success will be quickly copied and that moats are needed to sustain any profit. The best venture capitalists are already leaving a market, when the poseurs show up. What is the moat in venture capital itself? My view is that it is cumulative advantage that causes a few firms to have persistently  higher returns. The best essay on this topic  was written by Duncan Watts and is entitled: Is Justin Timberlake a Product of Cumulative Advantage?   http://www.nytimes.com/2007/04/15/magazine/15wwlnidealab.t.html?_r=0

 

Notes:

Giants: http://web1.poly.edu/alumni/_docs/Giants-Kleiner.pdf

Economist Obituary:   http://www.economist.com/node/2265786

NYT Obituary: http://www.nytimes.com/2003/11/26/business/eugene-kleiner-early-promoter-of-silicon-valley-is-dead-at-80.html

KPCB: http://www.kpcb.com/design/on-investing-by-eugene-kleiner

Elad Gil:  http://blog.eladgil.com/2016/07/end-of-cycle.html?utm_campaign=digest&utm_medium=email&utm_source=app&m=1

A Dozen Entries from the Venture Capital Devil’s Dictionary

The Devil’s Dictionary is a satirical dictionary written by the American journalist and author Ambrose Bierce. This humorous book was originally published in 1906 as The Cynic’s Word Book. One of my favorite writers, Jason Zweig of the Wall Street Journal, is the author of the newly published and wonderful book: The Devil’s Financial Dictionary.

What follows are a dozen terms used in the venture capital industry, defined in Devil’s Dictionary fashion.

 

  1. “Burn Rate” the speed at which available cash is being consumed. Expenses such as inter-floor office slides, nerf guns, office space with water views, corporate retreats to other continents, dog chefs, and free Kind bars are sometimes put in a numerator of a fraction and expenses like salaries and electricity in the denominator, with the resulting number expressed as what is known as “an idiocy ratio.”

BurnRate

  1. “Chicken and egg problem” – describes a “which one came first?” problem, such as jump starting a multi-sided market. Explains why the first sale of fax machines was probably not just one machine. Which reminds me of a story: A chicken and an egg are lying in bed. The chicken is smoking a cigarette with a satisfied smile on its face and the egg is frowning and looking a bit pissed off. The egg mutters, to no-one in particular, “Well, I guess we answered THAT question!”

 

  1. “Dog and pony show”- a presentation that is long on showmanship and light on substance originally used in the United States in the late-19th and early-20th centuries to refer to small traveling circuses that toured through small towns and rural areas and startup pitches at Angel investor clubs composed of proctologists, dentists and beauticians.

dogandpny

  1. “Ducks are quacking, so feed them” – describes what some startups do when it is easy to raise cash (e.g., feed amateur Angel investors shares in return for cash). If a business does not hear ducks quacking and has no cash reserves raised during a period of time that was “quack rich,” the business may soon auger into the ground at high speed. Cash is financial Valium.

ducks

  1. “Exit strategy” – a plan to generate cash from the sale of a business or part of a business. The more a founder talks about his or her “exit strategy” the less attractive the investment. See also: Mercenary. Gary Larson has a Far Side cartoon strip in which one chicken is shown talking to another while they sitting on beach chairs holding umbrella drinks saying: “Man, they made me a free-range chicken and I never looked back.” A founder who is driven to be sitting in a beach chair holding an umbrella drink is not likely to be successful.

 

  1. Growth hacking”- a glorified term for sales and marketing using analytics. Using the word “hacking” as part of the term makes a non-technical person sound more like an engineer who seems to have a cooler job since they use words like grok, DevOps and Rails.

 

  1. “Hockey stick”- what a line on a chart representing something like revenue growth looks like when that distribution is calculated as a goal seek in a spreadsheet (up and to the right, to infinity and beyond).

hockey stick

  1. “Pivot”- a new direction or path for the business if the original idea turns out to be crap. Scott Adams of Dilbert fame writes: “For example, a company starts out selling PEZ dispensers online and later pivots to become eBay. You didn’t hear about all of the companies that failed so the pivot stories probably sounded more prevalent than they were. It’s similar to how a story of one shark attack makes you think there’s a Great White under every surfboard. The human brain assumes that whatever it hears most frequently must be the best reflection of reality.”

 

  1. Ramen profitable” – Just enough profit to afford to eat ramen with the “profits” of the business. Profit is unfortunately an opinion whereas absolute dollar free cash flow is a fact. While there may sometimes technically be “profit” based on someone’s definition/opinion there may not actually be cash to buy ramen. The instant noodles are usually purchased by the case or even a pallet from a “cash and carry” store or Costco.

ramen

 

  1. “Runway”- the number of months the available cash will last if the current burn rate continues. Not to be confused with “run away” which is what you should do when founders use words like “paradigm” or “e-business” in their pitch deck.

tweet rop

 

  1. “Telling someone their baby is ugly”- giving someone the news that their idea or creation is doomed to fail.  Best done by someone else. See: delegate.  As H.L. Menken once said:  “When A annoys or injures B on the pretense of saving or improving X, A is a scoundrel.”

 

  1. “Zero-billion dollar market”- A small unattractive market for a venture capitalist, often fought over by a group of businesses that reminds you of several bald men fighting over a hair brush. H/T Eugene Kleiner.

 

Notes:  

Jason Zweig- The Devil’s Financial Dictionary.  https://www.amazon.com/Devils-Financial-Dictionary-Jason-Zweig/dp/1610396995

Scott Adams: http://blog.dilbert.com/post/103051127931/the-pivot

VC Jargon: http://www.sherpapartners.com/Sherpa_Jargon.htm

Glossary: https://www.cbinsights.com/research-venture-capital-terms?ads_cmpid=270202443&ads_adid=24533358603&ads_matchtype=p&ads_network=g&ads_creative=86955087243&utm_term=vc%20terms&ads_targetid=kwd-142600249443&utm_campaign=&utm_source=adwords&utm_medium=ppc&ttv=2&gclid=CNzDjYubs80CFVKDfgodAhYGiA

 

 

A Dozen Things I’ve Learned From Mike Maples Sr. About Business and Investing

 

It would be difficult to overemphasize how important Mike Maples was to the success of Microsoft. Even more difficult would be trying to explain his personality which someone who knew him very well said to me “is several standard deviations away from what you would expect from a tech executive who started his career at IBM.” His personal impact on the lives, beliefs and skills of many people I know is nothing short of massive. He graduated from Oklahoma University with a bachelor’s degree in electrical engineering and earned his master of business administration at Oklahoma City University. Maples joined Microsoft on May 1, 1988. Maples was responsible for all product development and product marketing activities. By the time Maples eventually retired from Microsoft he was the executive vice president of the Worldwide Products Group and member of the Office of the President, reporting directly to Bill Gates. Maples is now an investor and rancher.

Bill Bliss: “Mike arrived from IBM and really shook things up.  He created the first Apps Division Business Units (BU’s) — if memory serves: Analysis Business Unit (Excel, Pete Higgins), Word Business Unit (led by Jeff Raikes), Graphics Business Unit (PowerPoint, led by Bob Gaskins, the founder of the company that created PowerPoint), Entry Business Unit (Microsoft Works, led by Susan Boeschen), and the Data Access Business Unit (Access, codenamed Omega at the time, led for a short time by the late and great Jeff Harbers).  Under each of these was Development, Product Management, Test, Program Management, and User Education. There was also a small shared Tools team reporting to Mike; at the time all the Microsoft applications used a proprietary compiler and other tools.” “This organization allowed each of the products to exist as little startups within the larger organization and it was the BU organizational framework and the strong empowered leaders Mike put in charge that enabled Excel to beat Lotus, Word to beat WordPerfect, and (later) Access to beat Ashton-Tate.  Strategy and execution were pushed all the way down into the organization; without that, the products never could have scaled the way they did.”

Bill Gates: “Mike Maples has been a key architect in [Microsoft’s] growth and success– few business leaders could claim a better record during a similar time.” Seattle Times, May 15, 1995.

The quotes from Mike Maples are in bold text as is usual:

  1. “You try not to have top down decisions. The team who is building Word knows more about that trade-off than I will ever know.” A number of people have told me that this was the most important idea that Maples brought to Microsoft. This principle arrived at just the right time and allowed the company to grow and scale. Decentralization can work extremely well if you have the right people and culture. I have written a post on how this principle is followed at Berkshire Hathaway. The fundamental idea is relatively simple: work really hard to get the right people with the right skills in position to do the work and let them do their job. As with most simple things, it is easy to say, but hard to do in practice.
  1. “I don’t care what process you use as long as you: A) know what it is and write it down; B) establish that you’re following it.  Anything that you can plan is fine with me.” All processes must include a post audit of what worked and did not work.  This would include all functions, be written down and published for all to read.  At the end and beginning of every project, the last post audit would be studied to insure constant improvement.Maples is again stressing the importance of delegation and pushing down responsibility to the people closest to the work. Even though the nature of the process that is used to build a business or create a product like software can vary with the team and the objectives, that does not mean that something like a written schedule can be omitted from that process or that the process can deviate from a zero defects standard of quality. The “writing it down part” is non-trivially important. As Warren Buffet says, if you can’t write it down, you have not thought it through.
  1. “What we tried to do was say that development has three trade-offs. You had quality, function and schedule, and that quality wasn’t an arguable- it was a must. So now you had to choose what function you were going to include on what schedule, but management could only choose one of them. So management would say- this product needs to be shipped in August, and the team would say how much function can I put in before August.” Development is a three-legged stool said Maples recently at a lecture at Stanford. All three legs are critical but managers should only be allowed to create a mandate related to either function or schedule. The team makes the other decision and quality is not negotiable since it must be as good as you can make it without constraints.   
  1. “A group of people that was so bright, and so hard-working, and so focused as Microsoft, you couldn’t tell them how IBM did it, or you couldn’t tell them how to change; but that they were always on a quest for discovery. So if you could frame a problem, they would work through trying to come to an answer, and they’d often come to you for advice as they were trying to craft their answer. And so I think that a lot of times the way things changed was not by autocratically saying, ‘We’re going to do this, or we’re going to have this.’ It was more of getting the people together and say, ‘OK. I’ve observed that we failed here. How do you think we should correct it?’ And then let them discover, and maybe throw in a few ideas, or a few suggestions along the way you know, kind of the ‘I’m a poor boy from the South, don’t know much, but let’s see if we can work this out.’ And it seemed to work pretty well. And the folks were so receptive.” One great way to get things done is to let other people think it was their idea. Another helpful other idea is to remember that people will often take advice better if they seek that advice out rather than a having it pushed on them without asking for help. Maples reminds me in his comments about being a poor boy from the South of another manager who is from Mississippi. I have written about this fellow named Jim Barksdale who is famous for his Barksdaleisms, like: “The infantry is always ahead of headquarters.” Another legendary manager Tom Murphy once described the best approach to decentralization of operating decisions this way: “Don’t hire a dog and try to do the barking.”
  1. “The management system I described is on the edge of control. By design, we didn’t centrally control many things. We let each product team pretty much run alone. And the way that worked was that they would have phases and would report where they stood against that, but we didn’t have management sign off or fixed reviews. The deal was that Bill or I could review any product at any time. We could change it or do whatever we wanted with it, but if we didn’t chose to review it, they didn’t stop and wait.  So there would be products for whatever reason we didn’t have time to deal with, that would go from conception to shipping without ever having a management review.” As a manager you can’t review everything. In my experience the best managers know when they smell something rotten and drill down when they sense it.  And when they sense something great they drill down so they can optimally fertilize it. Trusting the teams you build is an attribute of a great leader. So is the process of holding great review when you do so.
  1. “Good ideas without passion and execution never work. A lot of companies that fail didn’t believe with all their hearts that this was the most important thing to be doing and they didn’t focus. Any time you have pivots 4-or-5 times a year you haven’t got enough focus. If you don’t give ever give x a chance to work out, it never will.” People [at Microsoft] worked incredibly long hours. And I can remember who was it? Was it, maybe, Jabe Blumenthal. Somebody was working on a projection a database project, and they didn’t leave their office for six weeks. You know, they slept, and ate, and lived in their office. I remember going by and finding people with their hands just on the keyboard just asleep. You know, they’re just they’d been there until they’d just stopped thinking.” “These individuals were working to complete the commitment they made to their team, not what the company or manager expected of them.” A lack of focus can be a killer problem for a business. It is vital that a business to pick its objectives well and not get too distracted by chasing every new thing that may appear. Staying focused on the needs of the customers and basics like planning for growth and cash management can help reduce distractions. When you see a great business it is surprising how much success is attributable to doing a small number of things extremely well. Former Microsoft executive and venture capitalist Mike Slade told me: “Jeff Harbers also lived in his office while laboring to ship Microsoft File 1.0 for Mac, which shipped around Christmas 1984. Harbers bunked down in his office at 10700 Northup Way.” In my post last weekend on Elon Musk he talks about how a business can win by simply working harder than competitors. Maples set an example for others. I recall walking by his office at Microsoft late one evening and there he was, the only person in the office wearing a white long sleeve short.
  1. “Keep commitments and schedules.”  “Do what you say you will do.” “Believe in yourself.” “It’s only over when you decide to quit.” “Work with kick-ass people who are committed to doing GREAT work.” “There’s something about the struggle, adversity, the trial and error and worrying at night about things that makes the entrepreneur better and stronger.” “I’m kinda driven by the concept that life dealt me an overly lucky hand. It had little to do with how smart I was. I was at the right place at the right time. Maybe you owe part of that back.” “If you look at the major tech companies, Bill Gates, Larry Ellison, Steve Jobs, they didn’t waste time going to college getting advanced degrees. They went out and built a company. The fact that you went to college means you may be a little conservative on the risk side…that’s not to say a PhD isn’t useful to running a company.”  The importance of values and culture to success in business is often underestimated since people do not tie it to the ability of a business to adapt to change and efficiently make decisions.
  1. “Have system that values the people and the product of their work, one that’s pretty non-political.” “Do what’s right. Sometimes you will be confronted with a situation where it’s harder to explain the right course politically but you will know it’s right brake the risk to stand for what’s right. Don’t hide facts to look good.” The venture Capitalist Mike Maples Jr. says about his father: “He used to hate it when someone would spring a ‘new’ fact on someone in a meeting for the purpose of having the upper hand. All discussions and meetings should start with all cards on the table and no hidden cards for political benefit.”
  1. “If you have 100 people and you want to add 80 more, you better have all 100 of them recruiting.” “Recruiting is best not done by HR but by people with skill like what you are trying to recruit ( developers hiring developers).  “I’d say the number one thing is we’ve managed to hire the best and the brightest. We hire people who are serious minded, and care, willing to work very hard, and are very smart. And I would put that very high on the list. The second thing is I think we have a really good value system, a value system that includes being financially conservative. You know, we don’t waste a lot of money.”“When you hire people, you will make mistakes about 10% of the time.  Not everyone will be a great fit.  Managers must correct mistakes as early as possible.  6 month is easier than a year or two later.  It is only fair to the individual to get them on a path to some other company where they can be maximize their success.” People underestimate how much time the senior management team of a growing business spends recruiting. And no one spends more time recruiting than the CEO at a well-functioning startup especially.
  1. “Acquisitions are hard to make work. We never thought about buying customers or revenue streams. We always thought about people and skill.”  People disagree about what percentage of acquisition fail. The number is big. Of course the Babe Ruth principle applies to acquisitions. It is magnitude of success and not frequency of success that matters most. The goal in investing as Warren Buffett has said is simple:“Take the probability of loss times the amount of possible loss from the probability of gain times the amount of possible gain. That is what we’re trying to do. It’s imperfect but that’s what it’s all about.” Diversification can help says Buffett: “If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually- independent commitments.  Thus, you may consciously purchase a risky investment – one that indeed has a significant possibility of causing loss or injury – if you believe that your gain, weighted  for probabilities, considerably exceeds your loss, comparably weighted, and if you can commit to a number of similar, but  unrelated opportunities.  Most venture capitalists employ this strategy.” In the end the goal is to make decisions based on expected value which is the weighted-average value for a distribution of those possible outcomes (multiply the probability of each possible outcome by its respective present value and sum those numbers).
  1. “You’re trying to build barriers to entry that keep your products installed and others out.” “You make sure that people understand the economic theories.” If there are no barriers to new supply of what you sell competitors will cause price to drop to a point where there is no long term industry profit greater than the cost of capital.  Michael Porter use the term “sustainable competitive advantage” to describe the objective of creating these barriers. Warren Buffett calls it a “moat.”  The two terms are essentially identical.  The principle is so simple and yet so many people think only about customers and not competitors as well.  Yes, innovate and deliver exceptional value for customers.  No, that is not enough for sustainable profitability. Revenue is not profit.
  1. “First place is the only place. Any strategy should be a strategy to lead.” “Some of the real rewarding times you know, when I came, I think we had 8% market share in spreadsheets, and it just seemed like forever that it just never changed very much. And then all of a sudden one day, you know, it seemed like in two months it went from 12 to 40, or something. It happened. And I was sitting with Pete [Higgins], and I said, ‘You know, some day we’re going to be in the lead, and we’re going to have the highest market share. We’re going to be the leaders, and what are we going to do then?’ And so it was kind of ah you know, that time that all of a sudden you had arrived.” “Stick-to-it-tiveness” is a success factor. But, by and large, working hard, working smart, smart people; and then really capitalizing on the mistakes of your competitors. You know, the reason Lotus lost out was not only the fact that we were there and pushed them hard, but the fact they just screwed up. The reason Word Perfect, the reason Novell you know, you can trace every one of them to senior management screw-ups. And we wouldn’t be where we are today if they hadn’t of no matter how hard we did. There’s so much momentum against change that unless the users really get frustrated with their installed vendors, they won’t change.” Maples is a strong believer in adopting a long term approach in any business. In a recent joint presentation with Steven Sinofsky at Stanford these attributes were called out by Maples: passion for products and technology, customer feedback, team work, individual excellence. In terms of culture:  strong work ethic, self-motivation,  driven / empowered, technical/business vision, a will to succeed, pride, individual identification with whole company, belief we can change the world, and high standards.

 

Notes:

Gaskins Interview: http://www.robertgaskins.com/powerpoint-history/documents/ensmenger-cbi-interview-mike-maples-oh387mm-2004-may-07.pdf

Interview: http://www.siliconhillsnews.com/2013/07/30/mike-maples-talks-investments-startup-smarts-and-bill-gates/   https://www.youtube.com/watch?v=AuKWMq0xq9Y

Quora: https://www.quora.com/What-was-Mike-Maples-Sr-s-role-at-Microsoft/answer/Mike-Maple s

Article: https://books.google.com/books?id=RC_5OCQQJ7YC&pg=PA287&dq=%22mike+maples%22&hl=en&sa=X&ved=0ahUKEwjT7YvUw9rMAhUH1GMKHVIXAQMQ6AEIIDAB#v=onepage&q=%22mike%20maples%22&f=false

Article: https://books.google.com/books?id=bZrPRKsUd2QC&pg=PA180&dq=%22mike+maples%22&hl=en&sa=X&ved=0ahUKEwjviJCbxNrMAhUQ0GMKHTZVB5Q4ChDoAQhDMAg#v=onepage&q=%22mike%20maples%22&f=false

Bill Bliss: https://www.quora.com/What-was-Mike-Maples-Sr-s-role-at-Microsoft

 

A Dozen Things Someone Might Learn about Investing and Business from the Simpsons

 

 

You can learn as much from anti-role models as role models.  Knowing what not to do is valuable. While Homer and other characters in the Simpsons are often among the more classic anti-role models, they are sometimes role models on issues like family loyalty.

1. HOMR-

  dance

Broker: “Okay, now before I execute this order, are you sure you understand the risks of stock ownership?”

Homer: “Absolutely!” [picture of Homer’s brain appears that includes a line of dancers line singing ‘We’re in the money’. ] “You heard the monkey, make the trade.”

The stock market will not deliver wealth to you, especially if you expect it to appear on some sort of schedule. That you can determine an asset is mis-priced now relative to intrinsic value does not mean you can time when the asset will rise to a price that is at or above its intrinsic value. The best investors wait for profitable result, rather than try to time markets.

 

2. Homer vs. Patty and Selma-

 

pumpkins

 

Homer: “This year I invested in pumpkins. They’ve been going up the whole month of October and I got a feeling they’re going to peak right around January. Then bang! That’s when I’ll cash in.” 

This dialogue from the Simpsons reminds me of Nassim Taleb’s story about the turkey:  “Consider a turkey that is fed every day. Every single feeding will firm up the bird’s belief that it is the general rule of life to be fed every day by friendly members of the human race ‘looking out for its best interests,’ as a politician would say. “On the afternoon of the Wednesday before Thanksgiving, something unexpected will happen to the turkey. It will incur a revision of belief.” Here’s a chart depiction of Taleb’s story:

taleb-thanksgiving-turkey

 

3. Lard of the Dance-

 

 greece

Homer Simpson: Okay, boy. This is where all the hard work, sacrifice, and painful scaldings pay off.

Employee: Four pounds of grease… that comes to… sixty-three cents.

Homer Simpson: Woo-hoo!

Bart Simpson: Dad, all that bacon cost twenty-seven dollars.

Homer Simpson: Yeah, but your mom paid for that!

Bart Simpson: But doesn’t she get her money from you?

Homer Simpson: And I get my money from grease! What’s the problem?


Marge: Homer! That side of bacon was for my bridge game tonight!

Homer: Marge, if you don’t mind, I’m a little busy right now achieving financial independence.

Marge: With cans of grease?

Homer: [sarcastically] No! Through savings and wise investment. Of course with grease.

Homer doesn’t understand what Bill Gates said once in his famous Playboy interview: “Take sales, take costs, and try to get this big positive number at the bottom.” July 1994

 

4. Homer the Vigilante-

 vig

 

Homer Simpson: “Aw, you can come up with statistics to prove anything, Kent. Forty percent of all people know that.”

Charlie Munger makes the same point in his own unique style: Without numerical fluency, in the part of life most of us inhabit, you are like a one-legged man in an ass-kicking contest.”

 

5. Bart Gets an Elephant- 

elephant 

 

Homer: “Look at this Marge, $58 and all of it profit. I’m the smartest businessman in the world.” Marge: “[The elephant’s] food bill today was $300”  Homer: “Marge, please, don’t humiliate me in front of the money”

Homer is operating this business at a negative gross margin.

 

6. No Loan Again Naturally-

foreclosure

Homer: “It’s a secret thing called a home equity loan. I get all this cash…and the house gets stuck with the bill!”

Homer: “When you gave me that money, you said I wouldn’t have to repay it ’til the future. This isn’t the future. It’s the lousy, stinking now!”

Leverage can be a very dangerous thing.  Next to liquor and drugs is it one of the most common sources of ruin.

 

7. The Flight Before Christmas-

 Krusty

 Krusty:  “Kid, this company’s bust. For years I’ve been giving away free toys and getting cookies in return. It’s not a sustainable business model.”

Krusty clearly has a problem with his business model and what he generates as income is insufficient to even recover his cost of goods sold.

 

7. The Old Man and the Lisa-

 burns

 Mr. Burns: “I’ll keep it short and sweet. Family, religion, friendship. These are the three demons you must slay if you wish to succeed in business.”

 Mr. Burns: “Smithers, why didn’t you tell me about this market crash!”  Smithers: “Um, well… sir, it happened 25 years before I was born.”  Mr. Burns: “Oh, that’s your excuse for everything!”

 Lisa [to Mr. Burns]: “If I did agree to help you, you could only earn money by doing good, socially responsible things. Nothing evil.”   Mr. Burns: “Nothing evil. That’s exactly the kind of radical thinking I need!”

Charlie Munger:  “I think you’ll make more money in the end with good ethics than bad. Even though there are some people who do very well, like Marc Rich–who plainly has never had any decent ethics, or seldom anyway. But in the end, Warren Buffett has done better than Marc Rich–in money–not just in reputation.”

 

8. Kamp Krusty-

 

 lottery

Homer: “Son, if you really want something in this life, you have to work for it. Now quiet! They’re about to announce the lottery numbers.”

This is a Charlie Munger riff on another point made above: “If you don’t get this elementary, but mildly unnatural, mathematics of elementary probability into your repertoire, then you go through a long life like a one-legged man in an ass-kicking contest. You’re giving a huge advantage to everybody else.”

 

9. The Twisted World of Marge Simpson

twisted 

 

 Marge: “I’m not wild about these high-risk ventures. They sound a little risky.”       

 Other woman: Tsk. Oh, Marge. You are such a wet blanket. If we’d listened to you, we wouldn’t have sponsored that Mexican wrestler.

Andy Rachleff on Angel Investing: “Everywhere I go in Silicon Valley I hear people discussing their angel investments. The conversations remind me of fish stories. People love recounting the one time they caught a big fish, not the many futile hours they spent waiting for a bite.”

 

10. Lisa’s Date with Density-

 destiny

 Homer: “Greetings, friends. Do you wish to look as happy as me? Well, you’ve got the power inside you right now. So, use it, and send one dollar to Happy Dude, 742 Evergreen Terrace, Springfield. Don’t delay, eternal happiness is just a dollar away.”

Homer: “Now we just sit by the mailbox and watch the money roll in.”

 Marge: “But you’re going to annoy thousands of people just to make a few measly dollars. It’s nothing but panhandling.”

Homer:  “Hello, this is Homer Simpson, AKA Happy Dude. The court has ordered me to call every person in town to apologize for my telemarketing scam. I’m sorry. If you can find it in your heart to forgive me, send one dollar to Sorry Dude, 742 Evergreen Terrace, Springfield. You have the power.”

This dialogue reminds me of this:

Jerry Sienfeld: This isn’t a good time.

Telemarketer: When would be a good time to call back, sir?

Jerry: I have an idea, why don’t you give me your home number and I’ll call you back later?

Telemarketer: Umm, we’re not allowed to do that.

Jerry: Oh, I guess because you don’t want strangers calling you at home.

Telemarketer: Umm, no.

Jerry: Well, now you know how I feel.

 

11. Pulpit Friction-

 Mr_Plow

 Homer is offered a job as the new church deacon and says: “Well, I’m not one for taking new jobs on a whim. But as we say in the snow plow business, I’m your astronaut.”

Avoid “ready fire aim” decisions in life and you will have a better life. Charlie Munger: “Just avoid things like racing trains to the crossing, doing cocaine, etc. Develop good mental habits.” “A lot of success in life and business comes from knowing what you want to avoid: early death, a bad marriage, etc.”

 

12. $pringfield-

 

casino

Mr. Burns: “I’ve discovered the perfect business.  People swarm in, empty their pockets, and scuttle off.  Nothing can stop me now.”

Burns: “By building a casino, I could tighten my stranglehold on this dismal town!”

Smithers:  “Sir, bad news from accounting: the economy’s hit us pretty hard.” Burns: “Heh, tough times, huh?  I’ve lived through twelve recessions, eight panics, and five years of McKinleynomics.  I’ll survive this.”

Gambling is net present value negative. Because it can become an addiction, it can produce real harm. Charlie Munger: “I knew a guy who had $5 million and owned his house free and clear. But he wanted to make a bit more money to support his spending, so at the peak of the internet bubble he was selling puts on internet stocks. He lost all of his money and his house and now works in a restaurant. It’s not a smart thing for the country to legalize gambling [in the stock market] and make it very accessible.”

 

Addendum:

Mr. Burns: “What good is money if you can’t use it to strike fear into the hearts of men.”

Mr. Burns: “I’ll bide my time. Revenge is a dish best served cold.”

Mr Burns: “Eternal happiness for one dollar eh? Hmmm, I’d be happier with the dollar.”

Homer: “Hello, this is Homer Simpson, AKA Happy Dude. The court has ordered me to call every person in town to apologize for my telemarketing scam. I’m sorry. If you can find it in your heart to forgive me, send one dollar to Sorry Dude, 742 Evergreen Terrace, Springfield. You have the power.”

Krusty the Clown: “Kids, we need to talk for a moment about Krusty Brand Chew Goo Gum Like Substance. We all knew it contained spider eggs, but the hantavirus? That came out of left field. So if you’re experiencing numbness and/or comas, send five dollars to antidote, PO box…”

Milhouse: “I can’t go to juvie. They use guys like me as currency.”

Krusty: “Here’s the deal. Every time you watch my show, I will send you… forty dollars! Voice: Checks will not be honored.”

Herbert Powell: [watching `Itchy and Scratchy’] “To think I wasted my life in boardrooms, and stockholders meetings, when I could’ve been watching cartoons!

Homer: “The three little sentences that will get you through life. Number 1: Cover for me. Number 2: Oh, good idea, boss. Number 3: It was like that when I got here.”

Homer:  “How is education supposed to make me feel smarter? Besides, every time I learn something new, it pushes some of the old stuff out of my brain. Remember when I took that home wine making course, and I forgot how to drive?”

Marge: “The plant said if you don’t come in tomorrow, don’t bother coming in Monday.” Homer: “Woo-hoo! Four day weekend!”

“Marge, don’t discourage the boy! Weaseling out of things is important to learn. It’s what separates us from the animals! Except the weasel.”

“Lisa, if you don’t like your job, you don’t go on strike. You just go in every day and do it really half-assed. That’s the American way.”

“Don’t struggle! You’ll only sink faster.”

“I think Smithers picked me because of my motivational skills. Everyone says they have to work a lot harder when I’m around.”

“Bart, you’re saying butt-kisser like it’s a bad thing!”

“I can’t believe it! Reading and writing actually paid off!”

“Mr. Scorpio says productivity is up 2%, and it’s all because of my motivational techniques, like donuts and the possibility of more donuts to come.”

“Now go on, boy, and pay attention. Because if you do, someday, you may achieve something that we Simpsons have dreamed about for generations: You may outsmart someone!”

“Trying is the first step towards failure.”

“Hello, Jerry? Homer Simpson. Remember last month when I paid back that loan? Well now I need YOU to do a favor for ME.”

Notes:

 HOMR- https://en.wikipedia.org/wiki/HOMR

 Homer vs. Patty and Selmahttp://www.drodd.com/simpsons-quotes/6-17.htm http://www.simpsonsarchive.com/episodes/2F14.html   http://www.springfieldspringfield.co.uk/view_episode_scripts.php?episode=s06e17https://en.wikipedia.org/wiki/Homer_vs._Patty_and_Selma

Lard of the Dance- http://www.imdb.com/title/tt0701117/quotes  

http://www.imdb.com/title/tt0701149/quotes

Bart Gets an Elephant- http://www.springfieldspringfield.co.uk/view_episode_scripts.php?episode=s05e17  http://www.simpsoncrazy.com/episodes/bart-gets-an-elephant

No Loan Again Naturally- http://www.springfieldspringfield.co.uk/view_episode_scripts.php?episode=s20e12http://simpsons.wikia.com/wiki/Bart’s_Inner_Child/Quotes

The Flight Before Christmas- http://simpsons.wikia.com/wiki/The_Fight_Before_Christmas

The Old Man and the Lisa-   http://simpsons.wikia.com/wiki/The_Old_Man_and_the_Lisa/Quotes

Kamp Krusty-  http://simpsons.wikia.com/wiki/Kamp_Krusty/Quotes

The Twisted World of Marge Simpson-http://transcripts.foreverdreaming.org/viewtopic.php?f=431&t=22024

Pulpit Friction-   https://en.wikiquote.org/wiki/The_Simpsons/Season_24

Springfield-   http://www.simpsonsarchive.com/episodes/1F08.html  http://www.imdb.com/title/tt0701040/quotes

Lisa’s Date with Destiny- http://simpsons.wikia.com/wiki/Lisa’s_Date_with_Density/Quotes

The Fabulous Faker Boys-   http://simpsons.wikia.com/wiki/The_Old_Man_and_the_Lisa/Quotes

 

A Dozen Things I’ve Learned from Elon Musk About Business and Investing

 

Elon Musk is a classic missionary founder who is more interested in changing the world and creating enduring businesses than just the financial rewards that may flow to him from the product or service. Mercenaries may sometimes succeed financially, but they do not bring as much lasting value to their communities. What a city and nation wants in terms of economic development are businesses that produce jobs, innovative products and services, a better quality of life and which add to the tax base over the long term.  I would rather have an Expedia, Zillow or Tableau in my community than a startup sold early in its potential life by the founder for tens of millions of dollars or even $1 billion, which then slowly (or quickly) disappears.

To cover the situation where a reader of this blog has been living in a cave, set out below is some background information on Musk before getting to his quotes and my own thoughts:

Elon Musk is a South African-born entrepreneur, engineer, and investor. “Musk became a multimillionaire in his late 20s when he sold his start-up Zip2 to Compaq. He taught himself to program and at 12 he sold a game called Blastar.  At age 17, in 1989, he moved to Canada and attended Queen’s University. “In 1992 he move to the US to study business and physics at the University of Pennsylvania. He graduated with an undergraduate degrees in economics and physics.” “In March 1999, Musk co-founded X.com, an online financial services and e-mail payment company, that eventually merged with Confinity, which operated a service called PayPal.” He is the founder, CEO and CTO of SpaceX and the  Chief Executive Officer, Product Architect and Chairman of Tesla Motors.

1. “People should be less risk averse when there’s not much at risk.’’ “When something is important enough you do it even if the odds are not in your favor.” Musk’s many successes in business and life are an excellent way to explain: (1) why financial returns from venture capital and research and development follow a power law and (2) why the creation of startups that are tape measure home runs in terms of success is enabled by other startups which fail.

The potential distribution of financial returns from the creation of a new businesses that is  “0 to n” is convex. I am not going to go very deep into the nature of convexity because most of my readers will stop reading. If you do get bored anyway skip to number 2 below.  In the Notes below, two people write on the nature of convexity:

 “In finance, convexity is a broadly understood and non-specific term for nonlinear behavior of the price of an instrument as a function of evolving markets. Oftentimes, financial convexities are associated with some sort of optionality embedded in the instrument.”

“The trouble is that convexity involves a whole bunch of seriously geeky math and computer models and normal people probably don’t want to go there. (I don’t even want to go there.)”

Investments which are instead “1 to n” are not convex. Nassim Taleb writes: “Payoffs from [convex investments like venture capital and] research are from Extremistan; they follow a power-law type of statistical distribution, with big, near-unlimited upside but, because of optionality, limited downside.” In other words, convexity is about bets that reflect an asymmetric possible distribution of outcomes. Taleb writes: “Convexity propositions should be embraced – concave ones, avoided like the plague.”  The billionaire investor Sam Zell puts it in more understandable terms for an ordinary investor or business person in this way: “Listen, business is easy. If you’ve got a low downside and a big upside, you go do it. If you’ve got a big downside and a small upside, you run away.”

This matrix below represents my attempt to better explain investments which are convex:

BOG BOG

Determining whether rights to a potentially convex investment are available at an attractive price requires expected value thinking. If you overpay for an investment which has convexity you are not making a bet with positive expected value. This is why the best venture capitalists and entrepreneurs like Musk and Jeff Bezos are involved in areas and technologies before they become popular. Once the crowds arrive in a given area of investment an investor must invariably overpay for any investments, competition becomes very significant and potential investments cease to be opportunities and instead become efficient ways to destroy wealth.

When you encounter a convex financial or other opportunity with little downside and very big upside, it is with your circle of competence and it is under-priced, you should bet BIG. If the big convex bet is financial you only need to be right once in a lifetime to be wealthy since it is magnitude of success and not frequency of success that determines the desirability of the result. This is the so-called “Babe Ruth Principle.” When you are looking for convex bets, often the best place to look is in areas where you encounter significant complex adaptive systems. Investing is a probabilistic activity. Areas where financial outcomes can potentially be impacted by positive Black Swans can be significant opportunities.

Convex propositions can be found most anywhere if you know how to look for them and Musk is certainly someone who knows how to find them. Discovering convexity is made easier if you want to do things that are uncommon and bold. The convexity is in a sidecar if you will with people who think big and differently. As an example, going to Mars is very important to Musk. When he and Jeff Bezos started their quest to substantially lower the cost of launch using unconventional methods, the bets were convex. A similar bet would not be nearly as convex now that they have has proven their approaches are viable. This is why venture investors and founders inevitably have both spectacular results and many failures. Taleb writes that the process works: “by negative information, reducing the space of what we do by knowledge of what does not work. For that we need to pay for negative results.”  If someone tries to take failure out of the process, innovation will cease. This is why Jeff Bezos recently wrote is a shareholder letter:

“One area where I think we are especially distinctive is failure. I believe we are the best place in the world to fail (we have plenty of practice!), and failure and invention are inseparable twins. To invent you have to experiment, and if you know in advance that it’s going to work, it’s not an experiment.”

As for assessing the “risk” of failure, Musk talks about in his quotes, how risky is something if you can’t conceive of failing? This passage from Jim Cantrell who was on the SpaceX founding team is enlightening:

“He is by far the single smartest person that I have ever worked with …  period.  I can’t estimate his IQ but he is very very intelligent.  And not the typical egg head kind of smart.  He has a real applied mind.  He literally sucks the knowledge and experience out of people that he is around. … I am going to suggest that he is successful not because his visions are  grand, not because he is extraordinarily smart and not because he works incredibly hard.  All of those things are true.  The one major important distinction that sets him apart is his inability to consider failure.  It simply is not even in his thought process.  He cannot conceive of  failure and that is truly remarkable.  It doesn’t matter if it’s going up against the banking system (Paypal), going up against the entire  aerospace industry (SpaceX) or going up against the US auto industry (Tesla). He can’t imagine NOT succeeding and that is a very critical  trait that leads him ultimately to success. He and I had very similar upbringings, very similar interests and very similar early histories.  He was a bit of a loner and so was I.  I recently wrote an op-ed piece for Space News where I also suggest that his ruthlessly efficient way to deploy capital is another great reason for his success.  He can almost smell the right way through a problem and he drives his staff and his organization hard to achieve it.  The results speak for themselves. …In the end I think that we are seeing a very fundamental shift in the way our world takes on the big challenges facing humanity and Elon’s Way as I call it will be considered the tip of the spear.”

Someone who knows Musk well once told me that to understand Musk you really have to understand how badly he wants to go to Mars. They said they have seen him turn down chances to earn more profit since he believed he could get to Mars faster by doing so. This person said to me: “If you want to predict what Musk will do, ask yourself: Will this help him get to Mars faster?” Existing providers of launch did not think they would encounter anyone who thinks this way. To illustrate this “0 to n” approach to investing and life, it is useful to look at something that Musk recently said:

“Essentially what we’re saying is we’re establishing a cargo route to Mars. It’s a regular cargo route. You can count on it. It’s going happen every 26 months. Like a train leaving the station. And if scientists around the world know that they can count on that, and it’s going to be inexpensive, relatively speaking compared to anything in the past, then they will plan accordingly and come up with a lot of great experiments.”

If someone thinks like Musk or Bezos and they are right about their investments, your competing business that did not make the same bets can be in big trouble. This is what happened to Blackberry. An anecdote about Musk that was recently in a Bloomberg article further illustrates the point:

“For France’s Le Gall, Europe’s contemptuous inability to take Musk seriously dates back years. He remembers a conference in Vietnam about a decade ago where the billionaire “showed up in torn jeans and with a plastic bag. He told us — the chiefs of the three biggest rocket launchers worldwide – ‘I am here and you are dead.’ One of us replied: ‘you talk, we launch.’ Had we known…”

2.”Focus on something that has high value to someone else, be really rigorous in making that assessment, because natural human tendency is wishful thinking.” “Great companies are built on great products.” “There are really two things that have to occur in order for a new technology to be affordable to the mass market. One is you need economies of scale. The other is you need to iterate on the design. You need to go through a few versions.”  ‘You’ve got to make sure that whatever you’re doing is a great product or service. It has to be really great. To go back to what I was saying earlier, where if you’re a new company – unless it’s like some new industry or new market that hasn’t – if it’s an untapped market, then you have more ability to – the standard is lower for your product or service, but if you’re entering anything where there’s an existing marketplace, against large entrenched competitors, then your product or service needs to be much better than theirs. It can’t be a little bit better, because then you put yourself in the shoes of the consumer and they say why would you buy it as a consumer. You’re always going to buy the trusted brand unless there’s a big difference. A lot of times an entrepreneur will come up with something that is only slightly better, and it can’t just be slightly better. It’s got to be a lot better.” “If you’re trying to create a company. It’s like baking a cake. You have to have all the ingredients in the right proportion.” There is a lot to unpack in this set of statements by Musk, but fundamental to a successful business is making really great products that people want to buy. Great products in this context means that they are not just a little better than what competitors sell or that people already have, but a lot better. This simple fact seems so obvious, but some people get so caught up in trying to “start a company,” that they don’t pay enough attention to creating the products that define the business. How much better than the offerings of competitors must the product be? There is no formula to determine the correct result, but the answer is “a lot.” The SpaceX example is a quite interesting case to examine this question. Launching payloads into space on rockets has traditionally been thought of as a business that does not result in significantly more demand if there is a price drop. This assumption about price elasticity resulted in the traditional space launch providers deciding to milk their sunk non-recurring engineering and not invest significant amounts in new price reducing innovation. In short, these traditional launch providers believed that a lower prices would not result in more profit so they kept prices flat to increasing. This price elasticity assumption by the incumbents created an opportunity for Musk to innovate by relaxing another assumption which was that reuse of rocket stages was not possible. Musk reasoned that if Columbus and other explorers of his era had been forced to throw away their ships after every voyage not much would have been accomplished. Musk has proven that part of rockets can be reused and that other price reducing innovations are possible. Musk now must demonstrate that more rocket launches will be purchased due to the lower price so as to increase the total addressable market (TAM) for launch. For example, a price drop from $375M to $100 Million for a heavy rocket launcher would be a significant price cut.  How many more heavy launches will be generated at the new lower price? No one really knows yet. We can expect Musk to be innovative in looking for ways to increase launch demand. For example, the huge communications satellite constellation Musk has proposed is arguably an example of him looking for ways to create new payloads for SpaceX.

3.”It’s OK to have your eggs in one basket, as long as you control what happens to that basket.” The key word in this quotation is “control.” If you take dependencies on others and you have no alternative supplier  (i.e, what Roger Fisher calls no BATNA) the suppliers can block your success. For example, if you build a rocket and you must source your booster from a single supplier, then that supplier controls your fate. This is why Musk prefers to make everything he needs or have multiple suppliers. He does not want to buy components from traditional suppliers of launch who want the price of launch to remain high. This is a set of problems related to what I have called “wholesale transfer pricing” in other posts on this blog. Michael Porter calls it “supplier bargaining power.” Having all your eggs in one basket is a concentrated bet. Warren Buffett has a view on concentrated bets that is similar to Musk. Buffett says:

“Diversification is a protection against ignorance. It makes very little sense for those who know what they’re doing.” “I can’t be involved in 50 or 75 things. That’s a Noah’s Ark way of investing – you end up with a zoo that way. I like to put meaningful amounts of money in a few things.” “We believe that a policy of portfolio concentration may well decrease risk if it raises, as it should, both the intensity with which an investor thinks about a business and the comfort-level he must feel with its economic characteristics before buying into it. In stating this opinion, we define risk, using dictionary terms, as ‘the possibility of loss or injury.’”

4. “[Physics is] a good framework for thinking. Boil things down to their fundamental truths and reason up from there.” The famous physicist Richard Feynman is a hero to many people, especially to anyone who likes to think about thinking. Feynman was a great believer is being able to understand each step of the reasoning involved in an idea from first principles. David Goodstein once said to Feynman:

“Dick, explain to me, so that I can understand it, why spin one-half particles obey Fermi-Dirac statistics.” Sizing up his audience perfectly, Feynman said, “I’ll prepare a freshman lecture on it.” But he came back a few days later to say, “I couldn’t do it. I couldn’t reduce it to the freshman level. That means we don’t really understand it.”

Warren Buffet believes the same things about business principles. If you cannot write it down, you have not thought it through. In a previous blog post I compared Feynman to Charlie Munger who also has bottom’s up thinking process. What are the factors that really govern the interests involved, rationally considered? What are the influences where the brain at a subconscious level is automatically forming conclusions that may be dysfunctional or incorrect?  Munger’s style is to first assemble all the relevant facts and then apply a rational process to produce an analysis of those facts and an investing thesis. Even if you can’t rely on the same principles as physics in business you can adopt its basic ethos.

5. “Starting a business is not for everyone. Generally, starting a business, I’d say, number one is have a high pain threshold. There’s a friend of mine who’s got a good saying which is that starting a company is like eating glass and staring into the abyss. That’s generally what happens because when you first start a company – there’s lots of optimism and things are great. Happiness at first is high, then you encounter all sorts of issues and happiness will steadily decline, and then you will go through a whole world of hurt, and then eventually, if you succeed – and in most cases you will not succeed. Tesla came very close to failure. If you do succeed, after a long time, you will finally get back to happiness. “ “[Starting a company is like] staring into the face of death. If that sounds appealing, go ahead.” “Persistence is very important. You should not give up unless you are forced to give up.” “You will encounter issues you didn’t expect, step on landmines. It’s bad. Years 2 to 4 or 5 are usually quite difficult. A friend has a saying, it’s ‘eating glass and staring into the abyss’ … “If you’re cofounder or CEO, you have to do all kinds of tasks you might not want to do … If you don’t do your chores, the company won’t succeed … No task is too menial.” Starting a business is as brutally hard as Musk describes. If you like doing things that are brutally hard, and some people do, then you may want to start a business. And if you don’t like doing that, then don’t. It’s that simple. Of course, just liking challenges and hard work is not enough to create success since the founders must have the other required inputs like the necessary skills, significant innovation, a big addressable market and the ability to assemble a great team.

6. “Constantly seek criticism. A well thought-out critique of whatever you’re doing is as valuable as gold, and you should seek that from everyone you can, but particularly your friends. Usually, your friends know what’s wrong, but they don’t want to tell you because they don’t want to hurt you. Yeah, they say I want to encourage my friend so I’m not going to tell him what I think is wrong with his product. It doesn’t mean your friends are right, but very often they are right, and you at least want to listen very carefully to what they say.. and to everyone. You’re looking for, basically, you should take the approach that you’re wrong. That you, the entrepreneur are wrong. Your goal is to be less wrong.” “Pay attention to negative feedback and solicit it, particularly from friends. Hardly anyone does that, and it’s incredibly helpful.” ” It’s very important to have a feedback loop, where you’re constantly thinking about what you’ve done and how you could be doing it better.” “Some people don’t like change but you need to embrace change if the alternative is disaster.” To learn from success or failure you need effective feedback loops. Some people take feedback better than other particularly if it is criticism. Musk and people like him are very thick skinned and have a scientific orientation. The best approach is to have “strong ideas weakly held.” Someone with strong ideas should know the topics well and have researched all side of the issues. By keeping this strong views weakly held the person can adapt as new information and idea arrive. What people struggle with most is learning from mistakes. Charlie Munger has views that are quite similar to Musk on this topic. Munger says: “Why not celebrate stupidities?” “I like people admitting they were complete stupid horses’ asses. I know I’ll perform better if I rub my nose in my mistakes. This is a wonderful trick to learn.” It is through the process of making mistakes and having success in the real world that you can learn and establish sound business judgment.

7. “Work like hell. I mean you just have to put in 80- to 100-hour weeks every week. [This] improves the odds of success. If other people are putting in 40 hour work weeks and you’re putting in 100 hour work weeks, then even if you’re doing the same thing, you know that you will achieve in four months what it takes them a year to achieve.” The work ethic of Elon Musk is legendary. He has been described at working 15 hours days and sleeping six hours a night. Musk’s ex-wife talks about his work habits this way: “I had friends who complained that their husbands came home at seven or eight. Elon would come home at eleven and work some more. People didn’t always get the sacrifice he made in order to be where he was. He does what he wants, and he is relentless about it. It’s Elon’s world, and the rest of us live in it.” This set of quotes about the value of hard work and working harder than your competitors from Musk makes me think of Michael Mauboussin’s point that if you can work to change the outcome of something what you do to impact that outcome isn’t luck. The cause of that success is instead hard work or skill.

8. “I don’t think it’s a good idea to plan to sell a company.” “My motivation for all my companies has been to be involved in something that I thought would have a significant impact on the world.” As I said above, Musk is the poster child for the value of the missionary as opposed to the mercenary founder. Missionaries are more likely to get through the hard tasks, stress and hardships involved in building a business because they have the drive to succeed. Sometimes a great success is only inches from failure before is eventually breaks through to become a great success. It isn’t easy to have people say you are wrong or even crazy. People say that in the early days of Space X his goal was to “the Southwest Airlines of Space,” which is not the goal of a mercenary, but rather a missionary. Investors who back missionaries instead of a mercenaries are not only doing the right thing for society they will be more successful financially. Missionaries possess the key quality that Taleb describes as follows: the remarkable ability to engage in rational forms of  trial and error, with no comparative shame in failing again, starting again, and repeating failure.”

9. “Any product that needs a manual to work is broken.” I love this quote since I do not like to read manuals. I am glad manuals exist, but they are not my passion. Some people love to read manuals. I am not one of those people. The way great designers and engineers can reduce of eliminate the need for a manual is a beautiful thing to see. Some people seem naturally suited for this work just as they are for understanding what consumers will like and buy. As an example, one of my favorite things in life is to watch my friend Craig McCaw handling a new device. Craig is dyslexic and is someone who does not enjoy reading a manual. That is part of what gives him special insight into the mind of a consumer. He has the best instincts for what consumers will buy that I have ever seen.

10. “If things are not failing, you are not innovating enough.” It takes you very little time reading this blog you know I am fond of the ideas of Charlie Munger. He said once:There’s no way that you can live an adequate life without many mistakes.” Munger’s partner Warren Buffett agrees: “I make plenty of mistakes and I’ll make plenty more mistakes, too. That’s part of the game. You’ve just got to make sure that the right things overcome the wrong.” As I explain above failure is an essential part of harvesting optionality. It is how we acquire the information necessary to innovate. A system without failure is a system that will not progress. The economist Allan Meltzer created the following aphorism to capture this idea: “Capitalism without failure is like religion without sin. It doesn’t work. Alternatives to capitalism concentrate power in few hands, opening the way to tyranny and brutality, not justice.”

11. “The market is like a manic depressive.” This is so close to the “Mr. Market” metaphor that it is hard to imagine that Musk has not read the work of Ben Graham. He has at least read about the ideas of Warren Buffett who calls Mr. Market “a drunken psycho.”  Anyone who thinks the market is always wise is not paying attention. Entrepreneurs and investors like Musk are able to figure out where conventional wisdom is wrong so as to create or purchase under-priced optionality. These entrepreneurs are searching for positive optionality in an environment filled with the mistakes of other people. When the market is depressed is often the best time to invest and start a business. Talent is more available in a downturn if you can find the necessary cash or raise it during good times. This is why venture capitalist Eugene Kleiner once said: “When they are passing the hors d’oeuvres take two.” In achieving his many objectives in recent years Musk has had the good luck to be operating in favorable capital markets. If luck shines on you you for any reason, you should not only take a bow, but take full advantage of it while the sun shines.

12. “I think it matters whether someone has a good heart.” “I don’t believe in process. In fact, when I interview a potential employee and he or she says that ‘it’s all about the process,’ I see that as a bad sign. “The problem is that at a lot of big companies, process becomes a substitute for thinking. You’re encouraged to behave like a little gear in a complex machine. Frankly, it allows you to keep people who aren’t that smart, who aren’t that creative.”  Once upon a time, I interviewed with Craig McCaw for a job. I don’t remember much about our conversation specifically other than it was very pleasant and we talked about any things.  My favorite memory of that day was speaking to someone after the interview and being told that Craig thought I had: “a good heart.” Just thinking about that feedback makes me smile.  More than anyone in my life, Craig McCaw taught me about the value of avoiding conventional thought, action and processes. People who worked at McCaw companies thought of ourselves as pirates and Craig encouraged that approach. Like Musk, McCaw hates process and bureaucracy.  The former Bell companies were our competitors and we took pride in operating with unorthodox strategies and tactics when facing them and others as competitors. We were encouraged by Craig’s example to think for ourselves and be creative. In terms of his approach to business, Craig is more like Elon Musk than anyone I know. Their personalities are quite different it seems, but their “I would rather be a pirate than join the Navy” attitude toward business is very similar.

 

Notes:

Convexity first quote above: https://www.math.nyu.edu/~alberts/spring07/Lecture4.pdf

Convexity second quote above: http://www.calculatedriskblog.com/2008/01/options-theory-and-mortgage-pricing.html#cl1cBzYOySQBWHQs.99

Wired Interview:  http://www.wired.com/2012/10/ff-elon-musk-qa/

Dell Keynote, December 12, 2013  http://shitelonsays.com/transcript/opening-keynote-with-michael-dell-and-elon-musk-austin-tx-2013-12-12

PBS Transcript  http://www.pbs.org/thinktank/transcript1292.html

USC Commencement Speech  https://gist.github.com/johnz133/7bf10e77d8b994bae743

TED talk:   https://www.ted.com/talks/elon_musk_the_mind_behind_tesla_spacex_solarcity/transcript?language=en

Other talks: http://shitelonsays.com/transcript

Cantrell on Quora:  https://www.quora.com/How-did-Elon-Musk-learn-enough-about-rockets-to-run-SpaceX

Biography by Vance:  http://www.amazon.com/Elon-Musk-SpaceX-Fantastic-Future/dp/0062301233

Wikipedia:  https://en.wikipedia.org/wiki/Elon_Musk

Biography.com http://www.biography.com/people/elon-musk-20837159

Bloomberg: http://www.bloomberg.com/news/articles/2016-06-10/musk-s-spacex-once-pooh-poohed-is-wake-up-call-for-europeans

A Dozen Things I’ve Learned from Pitch Johnson about Venture Capital and Business

 

I decided last week that the next post in this series should be about Franklin “Pitch” Johnson, Jr. who has been a venture capitalist since 1962. It is a good follow up to my previous post on Georges Doriot and posts I have written on Arthur Rock and Don Valentine. These people and a few other innovators created the venture capital industry. Johnson is a founding partner of the venture capital firm Asset Management, which has made more than 250 investments during its more than 40 years of operation. The firm’s investments include Amgen, Applied Bio Systems, Applied Micro Circuits, Sierra Semiconductor, Tandem Computer, Teradyne and Verity. Johnson developed and taught a well-known course in entrepreneurship and venture capital at Stanford from 1979-1990.

 

  1. “This is a big argument between me and my good friend Don Valentine, a founding partner of Sequoia Capital. The first thing you look for in an entrepreneur is a sense of integrity, honesty, openness, and decency. Once you think you have found a decent person, the second thing is: Do they have a clear vision of the marketplace they want to serve? Don believes that you need decent people, but the marketplace comes first, because you can’t change that, but you can change the people.” One way to look at venture capital investing is as a three stool with three legs: people, markets and innovation. All three legs are required for success, but different venture capitalists put different emphasis on different legs of the stool at different times. This is especially true in the very early stages of a business. Johnson believes that the “people” leg of the stool  is more critical than Valentine, who was famously involved in replacing the founders at Cisco. I prefer Johnson’s approach since replacing people in any business, including a startup, is not only unpleasant but often not successful. Johnson seeks teams composed of people who not only have desirable qualities like integrity, honesty, openness and decency but also a clear vision about an attractive market. Johnson’s preference to invest in firms that do not need a management change is more like the approach of Warren Buffett and Charlie Munger who won’t buy a business if it does not come with management with the necessary skills and integrity.

 

  1. [Don Valentine and I] both ask: Do they have a differentiated ability? Is their product workable? Do they have enough of a different idea that they will be free of certain kinds of competition? Will the business operate with good margins?” Both Johnson and Valentine agree that if a business performs the same activities as its competitors it won’t have significant barriers to entry. I am not aware of any successful venture capitalist who does not believe a moat is required to generate a sustainable profit. The key strategy questions that every business should ask related to moats include: (1) what will the businesses will do differently than its competitors? (2) what sustainable advantage can the business create versus competitors and (3) is that differentiation sustainable in the face of competition? These strategy questions are quite different than matters relating to what Professor Michael Porter “operational effectiveness.” Without a moat, competition among suppliers will inevitably cause increases in supply, which will cause price to drop to a point where there is no long term industry profit greater than the cost of capital. When Buffett says “microeconomics is business,” this is what he means. Too much supply is bad for profits. It is that simple.

                                  

  1. “You’re trying to find people with good ideas and the ability to make those ideas into companies. Lots of people think we’re investing in technologies. That is not really a correct statement. We’re backing  people who can take technologies and serve markets, thereby serving people and building great companies.” “You concentrate on building a good company, which means getting the right people, having great products, marketing them well, having a good organization, and getting adequate financing in the thing to make it happen. And those are the immediate objectives, because if you don’t achieve those things, the rest of it doesn’t count.” As stated above, the three legs of the stool in venture capital are: people, markets and innovation. The process of taking innovation and turning it into value is the essence of a business model.  Johnson has identified the key steps in that process and the objective, which is to build a scalable business that delivers unique sustainable customer value. Venture capitalist Mike Maples, Jr. describes a business model as “the way that a business converts innovation into economic value.” The innovations that underlie the business are absolutely necessary, but not sufficient. Johnson is saying that his early focus in evaluating a startup is more focused on making sure the right people and team are in place.

 

  1. “We look for zeal. We look for guys who give a damn—and women—that want to make things happen. You can be as bright technically, you can understand marketing, you can do all the intellectual part of it right. But if you don’t yourself feel it and stimulate in your employees this same winning team feeling, you’re much less likely to succeed.” “If you don’t feel excitement, you’d better find another business.” “Entrepreneurs, the men and women that start companies, are quite competitive. They’re athletic in that sense of the word. Some have been athletes, some haven’t, but they have that drive to succeed, this unwillingness to fail, that’s characteristic.  The venture capitalists—the good ones—the best ones, share this enthusiasm, this zeal that they have. So they sense that you’re as zealous as they are to succeed.” The best entrepreneurs don’t quit when inevitable problems arise during the process of turning an idea into a successful business. These people are often referred to as missionaries. In other words, the ideal founders have a burning desire to create the business that is not just driven by money. The importance of perseverance is part of what Ben Horowitz writes about in The Hard Thing About Hard Things. Johnson is saying that entrepreneurs should look for the same missionary qualities in their investors and advisors.

 

  1. “Running out of cash gets your attention [as an entrepreneur]. The sight of the gallows clears your mind. [The mistake I often see entrepreneurs making is] running out of money. Often they plan to grow faster than reality will permit. They are too optimistic.”  One of the risk levels that you have to think about is will you be able to get enough money together to make this thing succeed? Companies can get a great idea with great leadership. If they don’t have enough money they can’t develop their products.” You can be forgiven for a lot of things in business, except running out of cash. Many accounting problems can eventually be overcome as long as the business has access to cash, which is the oxygen of business. Even bankruptcy can sometimes be survived if the business has enough cash. How much cash to raise and how much cash to burn are questions that involve judgment in the face of risk, uncertainty and ignorance. There is no magic formula that can be used to answer cash management questions, but having enough cash for nine months of operations is a common standard. If you don’t have that much cash on hand it is a good rule of thumb to be working toward raising more funds. At only six months of cash remaining it should be a major priority. At three months of cash remaining, the CEO and the CFO should be thinking about raising more cash first and foremost.

 

  1. “[Entrepreneurs] treasure and love independence. They love their feeling of being self-reliant, or a group bring self-reliant. They know that if they work hard and are right, in the end they’ll make some good money, which is certainly a primary aim. But they also can live with uncertainty, they can live with risk—they can sleep. I know people that can’t be in little companies—it just makes them too nervous. And they’re not good or bad people, they’re just people. So you have to be able to sleep when you have no idea what’s going to happen to you. Venture capitalists all learn how to sleep when things are going to hell.” “We knew that if you’re going to attract good people, whether they’re scientists or down the line, you want to have a plan so that everybody feels like an owner, and that if you had an option and the company succeeded greatly, then people were incentivized by that.” Johnson is describing a few of the qualities that a venture capitalist looks for in a founder.Getting the balance right so the startup has the best opportunity is not simple. Making everyone involved feel like an owner of the business is central to success.  It takes a special person to be an entrepreneur and is not something everyone is suited for. For example, as Daniel Kahneman has written, “For most people, the fear of losing $100 is more intense than the hope of gaining $150. [Tversky and I] concluded from many such observations that ‘losses loom larger than gains’ and that people are loss averse.” Kahneman also points out:

“It is costly to be risk averse for gains and risk seeking for losses.” “Many unfortunate human situations unfold [. . .] where people who face bad options take desperate gambles, accepting a high probability of making things worse in exchange for a small hope of avoiding a large loss. The thought of accepting the large sure loss is too painful, and the hope of complete relief is too enticing, to make the sensible decision that it is time to cut one’s losses.” “When action is needed, optimism, even of the mildly delusional variety, may be a good thing.” “The optimistic risk taking of entrepreneurs surely contributes to the economic dynamism of a capitalistic society, even if most risk takers end up disappointed.”

  1. “There are three ways in which venture capitalists [are involved with a business.] “I always think of it as capital, consulting, and commitment.”The first one, they provide money to give the company some capital to operate with. [The second], they provide advice and help, and on a frequent basis, weekly in young companies very often, certainly not less than monthly. The balance is between advising the management and trying to run the company yourself. “If you get the management too dependent on you, or you’re too assertive and they get too resistant, you’ve got to get this balance of discussion of keeping things open so that people will ask you stuff sometimes. But the worst thing you want to hear is have a guy come to a board meeting and he says, ‘I have three courses of action. Which one does the board want to take.’ That’s really bad news when a guy does that. What you want a guy or woman to come in and say is ‘Here’s where I want to go.” If you don’t like it then you can argue about that, but you don’t want them dependent on you for operating decisions.” Johnson believes that capital is only one element that an venture capitalist should provide. Venture capital is fundamentally a service business. Success in the venture business requires hustle, wisdom, judgment and hard work. If all a founder needs is capital then they are quite lucky indeed. Johnson is also saying that board’s primary role should be as advisors to management, not running the business. Someone like Johnson has seen many different boards and knows how important a good board is in terms of increasing the probability of success.

 

  1. “This is true of any venture: you don’t think about losing money, you think about what an investment can do, especially startup venture capital in some strange area. So you use your hunches, you use what you read, you use your sense of the practicality of the science, where the science is workable. You bring all that together on kind of a judgment call. I was trying to tell my class when I taught it—you can’t calculate all this. You should run the numbers— you have to run the numbers, but in the end you’ve got to have a sense of balance of the likelihood of success and what you need to do yourself to make things succeed. And the venture capitalist can play a substantial role in success by selecting the right people, encouraging them, getting them incentivized, and then helping the companies devise strategy. That’s an important venture capital function.” Venture capital is all about judgment. The way to get better judgment is to pay attention to your mistakes and the mistakes of others (and conversely the successes). Good judgment comes from experience, which often comes from bad judgment.  A venture capitalist never has all the data and an investing decision simply can’t be made based on a formula. A really smart venture capitalist said to me once that success in the “picking” part of venture capital mostly about pattern recognition. The more businesses you see in your career, the better you can get at spotting the patterns that can lead to success.

 

  1. “[Georges Doriot, my Harvard Business School professor] said: ‘Remember there’s a great tape recorder going all the time,’ which is fairly true. So what he was saying is, ‘Behave yourself, because if you’re going to cut corners, you can’t.’” “When we were first starting our firm, a lawyer, Ed Huddleson, said to Bill [Draper]and me: ‘We can write all the investment agreements you want but if you have to bring them out of the drawer, something has gone wrong. Invest in people you can believe in, and you will never need to take the papers out of the drawer.'” One simple approach that can help guide personal and company behavior is to imagine that everything you do in life will appear on the cover of The New York Times. Would you be proud of what you have done? In interviews Johnson talks about how the venture capital industry he wants to work in is a place where handshakes matter and where people are good for their word. Of course, it can take years to build a reputation and just minutes to destroy it. Someone who takes any pride in how much time they spend in court litigating with other people and businesses is an idiot.

 

  1. “The whole portfolio isn’t so risky, but any one deal is risky.” “George Quist said it best—a friend of mine who was a founder of Hambrecht and Quist. He said that venture capitalists sleep like babies—they sleep for an hour and they cry for an hour! But I sleep fine. I’ve had nights when I’ve been happier than other nights, when I was worried about something, but I really have been able to get off to sleep and get a night’s sleep almost always.” “We all have had a series of things we could have done differently, but it’s a batting average, you know? And my batting average is good. I’m not the greatest slugger in the business, but I’ve got a good solid batting average for a long time. But involvement would be the cornerstone of what I believe venture capital is. Involvement and help to the companies.” When Johnson says “the whole portfolio isn’t so risky” this is what he means: In an essay in which he discusses the nature of risk, Warren Buffett advises: “If significant risk exists in a single transaction, overall risk should be reduced by making that purchase one of many mutually-independent commitments.  Thus, you may consciously purchase a risky investment – one that indeed has a significant possibility of causing loss or injury – if you believe that your gain, weighted for probabilities, considerably exceeds your loss, comparably weighted, and if you can commit to a number of similar, but unrelated opportunities.  Most venture capitalists employ this strategy.  Should you choose to pursue this course, you should adopt the outlook of the casino that owns a roulette wheel, which will want to see lots of action because it is favored by probabilities, but will refuse to accept a single, huge bet.” Founders by contrast have made a single huge bet. Chris Dixon has been both a founder and a venture capitalist so he has empathy for both venture capitalists and founders on this set of issues. He says: “VCs have a portfolio, and they want to have big wins. They’d rather have a few more lottery tickets.. while for the entrepreneurs, it’s their whole life, and let’s say you raised five million bucks, and you have a fifty million dollar offer, and the entrepreneurs are like, ‘Look, I make whatever millions of dollars. I’ll be able to start another company.’ And the VCs are like, ‘Wait! We invested billions of dollars.’ That is usually where tension comes.”

 

  1. “People forget San Francisco and Silicon Valley have their roots in pioneering. Failure is not unthinkable here. You can try again. In some places in Europe, however, it is a disgrace to fail and you have to retreat from business life.” “I think the most important single reason is the presence of two, now three, great research universities in the area—Stanford, Cal, and UCSF. But also, the presence of other important educational institutions that provide a great flow of engineers and people that aren’t scientists, although two produce engineers.” You simply can’t have a business like venture capital which is based on buying mispriced optionality and not have lots of failure. The failures are the price you pay to discover payoffs from optionality. Mistakes are inevitable. If there is a culture in a company, city or region that penalizes failure, there will not be  successful venture capital industry or startups. Johnson is also saying that in order to create a successful innovative climate any region also needs a critical mass of supporting services and resources. That means, most importantly, at least one major research university. I discussed that in more detail in my post this week on economic development.

 

  1. “My class [at Harvard Business School] was ’52. I don’t remember people talking about venture capital at all when I was in school. The term didn’t come up. I learned later that the term had been invented by Elton Mayo [a professor of Industrial Management at Harvard], in the early forties, middle forties.” “There were very few venture firms when Bill [Draper] and I got started in ’62. We had an informal group that met monthly for dinner. There were twelve of us and it was called the Western Association of Small Business Investment Companies, which itself was the forerunner of the Western Association of Venture Capitalists.” “The idea of angels—I’d never even heard of angels ‘til about twenty years ago [the late 1980s]. And that’s recent times.” “The word [angels] wasn’t used. Because we were all small, we were doing brand new startups a lot of the time, but not always. We did startups and we did deals that were already underway. The idea of angels only took place much later, when individuals were backing companies to get them going. Probably not fair, but I always think of angels as putting money in and seeing what happens.”  Pitch Johnson was in a good position to know who invented the term “venture capital.” It could be that Mayo was the originator. Some history buffs trace the term to Schumpeter who wrote an article in 1943 in which he uses the term “venture capital.” Another account http://www.startup-book.com/2012/03/31/prophet-of-innovation-joseph-schumpeter-and-creative-destruction/ makes a case that Schumpeter did not invent the term and that its origins are obscure. In any event, I agree with Johnson that the word “Angel” should be reserved for use in describing amateur early stage investors. Professional seed stage venture capital investors belong in another category.

 

Notes:

Stanford Business:   http://www.gsb.stanford.edu/insights/venture-capital-pioneer-illuminates-silicon-valley-ecosystem

Bio publications and papers http://www.gsb.stanford.edu/faculty-research/faculty/franklin-pitch-johnson

National Venture Capital Association Venture Capital Oral History Project http://digitalassets.lib.berkeley.edu/roho/ucb/text/dennis_johnson_donated.pdf

http://digitalassets.lib.berkeley.edu/roho/ucb/text/johnson_franklin.pdf

Bio: https://www.alumni.hbs.edu/stories/Pages/story-bulletin.aspx?num=11

IESE Interview  https://www.youtube.com/watch?v=o6oLLj1Zz2k

TiEcon  interview https://www.youtube.com/watch?v=9VmeF9LeqSU

https://www.youtube.com/watch?v=a-HMupXe6yE

https://www.youtube.com/watch?v=ff7OPt_afq4

 

 

A Dozen Things I’ve Learned from Georges Doriot (the Founder of the Modern VC industry)

Why should people want to read about an ex-U.S. General born in France who taught at Harvard Business School and formed the first venture capital fund? The answer is that this fellow unleashed an industry that is harvesting optionality in ways that are dramatically changing the world. Once people saw that was possible to generate 5,000X returns on a single investment as was the case with Digital Equipment Corporation (DEC) the world would never be the same.  As venture capital proliferated new value started to be unlocked at rates that the world had never been seen before. The change unleashed by the new torrent of innovation is so dramatic that some misinformed and disoriented observers actually claim that innovations levels have gone down.

Who was this pioneer Georges Doriot?

“Born in France in 1899, he came to the U.S. to get an M.B.A. and extended his stay, working for an investment bank and teaching at Harvard Business School. In 1946, he founded American Research and Development Corporation (ARD), the first publicly owned venture capital firm.”

“ARD was formed as a closed-end fund. That is, it raised permanent capital by selling a limited number of public shares.”

“For the first few years, ARD struggled. But then Doriot backed Ken Olsen, who worked at Lincoln Labs at MIT and wanted to build something called a ‘mini-computer.’ Doriot put $70,000 into Digital Equipment ARD made 5,000 times its money on that one deal, and venture capital was off to the races…. Doriot, along with New England industrialist, banker and politician Ralph Flanders and MIT president Karl Compton, passed the hat to the stodgy old companies and old money with a unique proposition: Let’s set up a fund that will invest in promising young companies, often companies with little or no sales and with little management experience but with potentially breakthrough technologies. Investors in Doriot’s funds included the academic institutions (Harvard, MIT, Penn) as well as stuffy old companies (Hancock, Home Insurance, State Mutual, Mass Investors Trust).”

 

  1.  “Someone, somewhere, is making a product that will make your product obsolete.” This is perhaps Doriot’s most famous quote. What Joseph Schumpeter called “creative destruction” is a constant process in the business world. Schumpeter  said: “the process of industrial mutation—if I may use that biological term— incessantly revolutionizes the economic structure from within, incessantly destroying the old one, incessantly creating a new one.” The paradox is that in order for productivity and standards of living to grow some aspects of the economy must be destroyed. Capitalism requires failure so new productivity and wealth can be created. Every business is in its own way constantly fighting this phenomenon: Warren Buffet once wrote: “Capitalism is all about somebody coming and trying to take the castle. Now what you need is a castle that has some durable competitive advantage — some castle that has a moat around it.” The moat of any business is always under attack by competitors even if you can’t see it. because moats are constantly under attack Charlie Munger points out that it is a rare company whose future is not a worse than its present. Schumpeter used the term “venture capital” as early as a paper written in 1943. Of course, ARD was itself a startup. The venture capital business itself once upon a time needed to find “product market fit.” As part of its business model discovery process, ARD eventually discovered that the venture capital business is driven by tape measure home runs. The idea that only one investment by ARD out of a much larger portfolio of scores on investments would overwhelmingly determine its financial success in venture capital was surely not anticipated by Doriot. The business world noticed that ARD’s success came from a single high tech investment, whereas ARD investments in businesses like tuna fishing failed. Merrill Griswold, a Director of ARD, once said to a Fortune reporter: “Some of our friends began to say: ‘Oh, Lord, not another longhair project. Why doesn’t ARD back something commercial and make some money?” We learned our lesson. Now we realize that our best things are longhair.” He is making the point I have made repeatedly in this series on my blog: in order to hit a tape measure financial home runs in venture capital you need to find a entrepreneur who is trying to create something that is half-crazy since that is where the necessary under-priced positive optionality can be found and purchased at a bargain. What Doriot did was highly unconventional at the time (H/T Ben Evans):

O DECK

  1. “The hardest part is to help a company through its growth pains. That is particularly hard because we have to work with others.” “Too many bankers and counselors have forgotten the history of the early years of our industrial giants of today. The first fifteen years of companies and of human beings are very much alike: hope, measles, failures, mumps, reorganizations, scarlet fever, executive troubles, whooping cough, etc. are parts of one’s daily life. Hopes, disillusions, hard work, are all necessary, particularly during the first ten or fifteen years before a stable and healthy body or corporation can begin to exist.” This set of quotations reminds me of some of the points made by Ben Horowitz in his book The Hard Things About Hard Things. Horowitz describes this process as “the struggle” and notes that there are no formulas for dealing with it. Mike Maples Sr. has said: There’s something about the struggle, adversity, the trial and error and worrying at night about things that makes the entrepreneur better and stronger.” ARD itself was a startup trying to create a new industry which would help people create important new businesses in important new industries. In trying to prove that venture capital was financially viable, Doriot faced battles and struggles related to raising money, politics and company governance. The book Creative Capital: Georges Doriot and the Birth of Venture Capital by Spencer Ante describes this period of time at ARD. By today’s standards the amounts raised an invested by ARD were small: “By the end of December 1946, ARD offices and its partner banks  were only able to sell 139,930 of the 20,000 shares, rustling up a total of $3.5 million Of the sum, just over $1.8 million was purchased by nine financial institutions, two insurance companies and four university endowments: MIT, Rice Institute, The University of Pennsylvania and the University of Rochester. Individual stockholders, required to invest the considerable sum of $5,000, contributed the rest of the capital.” It is clear that the leader of this movement to create a new form of finance for young companies was Doriot. Josh Lerner a professor at Harvard Business School points out: “Doriot is the founder of the modern VC industry. He is the first person who basically ran an institutional venture capital fund. And he played a lead role in getting the VC community to see itself as a real industry.” Doriot struggled to create a modern venture capital firm. He complained: “Yardstick measurements to be used in judging the work of a venture capital organization are very different from those of a normal industrial company. Methods of remuneration used by large manufacturing companies may be quite ineffective in attracting, keeping and rewarding personnel.” The task of ARD was described as follows by Doriot: “research and development, new technical ideas, and young small businesses are not in themselves the certain keys to great success. They must be supplemented by sound management, adequate financing, competent production methods, and aggressive merchandising.”

 

  1. “Never go into venture capital if you want a peaceful life. Keep on financing concrete that doesn’t move, that doesn’t call you at 2am in the morning.” Pioneering venture capitalist Pitch Johnson once said that part of what you must give to be a successful venture capitalist is “commitment.”  To be committed you can’t help but get somewhat emotionally involved and that means being available. Pitch Johnson said: “We invest stomach lining in those companies because any venture capitalist with his or her salt gets emotionally involved. You can’t be that detached because the entrepreneurs are very emotional people who want to succeed.” Doriot liked to refer to the businesses he invested in as his children since he was so emotional entangled in their success or failure. Doriot said once: “When you have a child, you don’t ask what return you can expect. Of course, you have hopes – you hope the child will become President of the United States. But that is not very probable. I want them to do outstandingly well in their field. And if they do, the rewards will come. But if a man is good and loyal and does not achieve a so-called good rate of return, I will stay with him. Some people don’t become geniuses until after they are 24, you know.”

 

  1. “The riskiest part of the spectrum has to date proved the most rewarding, and the greatest capital gains have been earned in companies which were started from scratch.” The venture capitalist Fred Wilson writes about the same topic raised by this quote from Doriot: “It’s not just the lower valuations you get at the formation stage, but it’s also that you are working from a blank slate with respect to everything and you can work with the founding team to form the culture, the strategy, the team, etc.” Venture capitalists like Doug Leone also prefer to be the “first outside dollar” in a new business saying the “DNA is set in the first 60 to 90 days.” 

 

  1. “Be careful of attempting to get publicity too soon or too much on a new investment. Remember the French proverb: ‘to live happily, live hidden’. Otherwise one only alerts competition to what you intend to do; it may bring in other venture firms’ money into competing technologies; if it goes wrong, you have a problem.” Flying under the radar can be an advantage for some companies as they struggle to get started. Doug Leone is also a fan of very young startups using in stealth to gain an advantage. Other people argue that this is the wrong approach and suggest that the entrepreneur should want everyone to know what the business is doing since it will need as much help as it can get from as many people who will contribute. On this one: vive la difference.

 

  1. “ARD in making an investment is in no way ‘gambling.’ Gambling is win or lose; ARD is the opposite, invest and build.” People who gamble are engaged in an activity which is net present value negative. Investing, for that reason, is not gambling although an investment is often called “a bet” since there is a chance that you can lose. The best investors only bet when the odds are substantially in their  favor and in the case of venture investing to find mispriced optionality (big upside and relatively small downside). Doriot wrote despondently at one point in the early 1953 “Venture capital is not fashionable any more. [People] search for security instead of hard work and daring opportunities. It is interesting to see how the great interest that existed seven or eight years ago in venture capital has disappeared and hoe the daring and courage which were prevalent at the time have now waned.” In December of 1953, ARD’s stock price hit an all-time low of $16 a share. That share price would recover, but it was not an easy time for Doriot at that low in the market. As is often the case in venture capital, it was one investment that turned the business of ARD around. ARD invested $70,000 “for a 70 percent  equity stake and promised additional loans.”

 

  1. “I don’t consider a speculator — in my definition of the word — constructive. I am building men and companies.” This quote hits the Ben Graham/Warren Buffett point about the difference between investing and speculation. In their 1934 book  Security Analysis, Benjamin Graham and David Dodd set out their definition of speculation: “An investment operation is one which, upon thorough analysis, promises safety of principal and a satisfactory return. Operations not meeting these requirements are speculative.” Ben Graham in The Intelligent Investor added that “Outright speculation is neither illegal, immoral, nor (for most people) fattening to the pocketbook.” Speculators focus on price and investors focus on on value.

 

  1. “The study of a company is not the study of a dead body… it is the study of things and relationships.  They are very much alive and constantly changing… it is the study of people and people’s work, of their hopes and aspirations… a study of determination of successive goals and of victorious competitive drive towards them.”  I have always been attracted to biological metaphors since both a business and an economy are complex adaptive systems and not something that is similar to a machine.  This means that an evolutionary outlook is helpful and a reason why a strong and diverse team is so valuable in any startup since they can adapt as conditions change. Doriot was part of a movement that changed many things in business. Its sort of odd to think about a ex-general born in France who taught at Harvard Business School leading cultural change but there it is. The cultural change created by companies funded by ARD, including Digital Equipment Corporation (DEC) marked the beginning of what we see today in technology. In Creative Capital: Georges Doriot and the Birth of Venture Capital Spencer Ante writes:

 Doriot

 

  1. “At the time it is made, a vital error can seem like a minor decision.” An error which you made five years before can kill your business. At the time you make a fatal error it can seem to be really small. There are many types of fatal error, one of which is not knowing what business you are in. As an example, Doriot said once: “U.S. Steel does not know what business they are in. They are in the materials not the steel business. They are completely ignorant of aluminum and plastics.” One can make this same argument about many companies include Kodak. Spencer Ante Wrote: By 1951 the company had invested in 26 companies employing over 3,000 people. Twenty-one of these companies were profitable. ARD had also begun charging consulting fees to portfolio companies in an attempt to raise revenues and further reinforce its business model.”

 

  1. “A committee is an invitation to do nothing. Very few committees can perform better than the weakest man.” Modern business vocabulary is full of expressions which are often used so loosely that they fail to convey anything to a perceptive listener.” “Sometimes I use [the stopwatch on my desk] to see how long it takes someone in a meeting to tell me the same thing three times.” Georges Doriot was an early critic of bureaucracy and anyone who places too much emphasis on process. He was stuffy and conservative in other ways but for him time he was a bit of a rebel too.  For example, he hated committees as do many other people.  Of course, jokes about committees are common. A common definition is: “A committee is a group of the unwilling, appointed by the unfit, to do the unnecessary” The relevant Milton Berle joke was: A committee is a group that keeps minutes and loses hours.” Elbert Hubbard said: “A committee is a thing which takes a week to do what one good man can do in an hour.”

 

 

  1. “You will get nowhere if you do not inspire people.” On a road somewhere, three men were breaking stones.  They were asked what they were doing:  One said, “I earn a living.” One said, “I break stones.”  One said, “I help build cathedrals.”  Let us build cathedrals together.” That Georges Doriot was a believer in the importance of leadership is not surprising. He was sometimes quirky in terms of the advice he doled out as a leader. For example, “When traveling, always adopt the psychology of a suitcase,” “If any information is to be exchanged over whiskey, let us get it rather than give it,” and “Always look relaxed when you are very tense inside. Never look mad unless you need to.” “A real courageous man is a man who does something when no one is watching him.” There is not a lot to say about this last quote other than it is true and that the older you get the more you appreciate it when you see it.“Without actions, the world would still be an idea.” I have met many people in my life who would have loved to start a business but they were never willing to do the necessary work and take on the associated risk. Talking about something is not doing something. Doriot believed: “An average idea in the hands of an able man is worth much more than an outstanding idea in the possession of a person with only average ability.”

 

  1. “A creative man merely has ideas; a resourceful man makes them practical.” One of the more admirable things Bill Gates and Paul Allen did when the formed Microsoft was drop what they were doing, ignored conventional wisdom and  moved to Albuquerque to chase what they saw as a huge opportunity that would not wait for them to finish other things. They acted. They and others in the technology industry grabbed fate by the ears and wrestled it to the ground. The most influential thing Georges Doriot did was fund Ken Olsen who created DEC.  ARD invested $70,000 for 70 percent of what would eventually become one of the world’s largest computer companies.  ARD eventually sold its holdings in DEC in 1972 for $450 million. It has been a recurring theme of these blog post that success in venture capital is driven by a tiny number of tape measure home runs. In the case of ARD, financial success was driven by one investment in DEC. Tom Nicholas of Harvard Business School wrote in his 2015 paper on the history of high tech venture investing in the US: “ARD was revitalized by a single investment, which also helped to spur the development of American VC more generally.”

 

Notes:

Creative Capital: Georges Doriot and the Birth of Venture Capital. Spencer Ante. http://www.amazon.com/Creative-Capital-Georges-Doriot-Venture/dp/1422101223/ref=sr_1_1?ie=UTF8&qid=1464498641&sr=8-1&keywords=Creative+Capital%3A+Georges+Doriot+and+the+Birth+of+Venture+Capital

http://news.harvard.edu/gazette/story/2015/02/the-talented-georges-doriot/

http://brie.berkeley.edu/publications/WP163.pdf

http://www.visionpioneers.net/diss_chapter7.html

http://www.pbs.org/wgbh/theymadeamerica/whomade/doriot_hi.html

http://www.informationweek.com/it-leadership/20-people-who-changed-tech-general-georges-doriot/d/d-id/1109773?

Fred Wilson:  http://avc.com/2008/05/doriot-quote-6/